Dynamic Competition in Negotiated Price Markets

This paper develops a framework for investigating dynamic competition in markets where price is negotiated between an individual customer and multiple firms repeatedly. Using contract-level data for the Canadian mortgage market, we provide evidence of an “invest-then-harvest” pricing pattern: lenders offer relatively low interest rates to attract new borrowers and poach rivals' existing customers, and then at renewal charge interest rates which can be higher than what may be available through other lenders in the marketplace. We build a dynamic model of price negotiation with search and switching frictions to capture key market features. We estimate the model and use it to investigate (i) the effects of dynamic competition on borrowers' and banks' payoffs, (ii) the implications of dynamic versus static settings for merger-studies, and (iii) the impacts from recent Canadian macroprudential policies.