Testing The Pricing-To-Market Hypothesis Case Of The Transportation Equipment Industry

Most of the evidence in favor of pricing-to-market (PTM) was obtained by estimating partial equilibrium models using OLS, instrumental variable (IV) and single-equation error-correction methods. However, we know from the recent econometric literature that Wald tests applied to some of these estimates may give erroneous results in the presence of endogeneity and weak instruments. In this paper we examine the reliability of the evidence supporting the hypothesis of pricing-to-market using LIML-based LR Monte Carlo tests. These tests, developed by Dufour and Khalaf (1998), have good power and, unlike the Wald test, also have the correct test size.We first estimate a typical PTM model by OLS and subject certain regressors to a test for exogeneity which does not depend on the "quality" of instruments used. Since the null is rejected, we then re-estimate the model by both IV and limited information maximum likelihood methods. Subsequently, we apply Wald and LR-based tests to the parameters of interest to examine the hypothesis of PTM. We find that the size-correct Monte Carlo LR-based test reverses half of the results obtained from the popular Wald test indicating that PTM may not be as widespread as previously believed. In addition, our results support the viewpoint suggesting that PTM behavior is likely to be present in the same industry across different countries and that pass-through is possibly higher with a larger market share of exports.The above findings are illustrated using the model developed by Marston (1990) and our analysis is conducted for export pricing firms in the transportation equipment industry for three country pairs: Canada exporting to the United States, the United States exporting to Canada, and Japan exporting to (mainly) the United States.