Dynamic Entry with Cross Product Spillovers: An Application to the Generic Drug Industry

55 Pages Posted: 9 Sep 2010  

A. Ronald Gallant

Duke University - Fuqua School of Business, Economics Group; New York University - Department of Economics

Han Hong

Independent

Ahmed Khwaja

Yale School of Management; Yale University - Cowles Foundation

Date Written: March 2010

Abstract

Experience in one product market can potentially improve firm performance in a related product market in the future. Thus, entry into a market is determined not just by profits in that market but also by its future impact on profitability in other markets. We formulate and estimate a dynamic model of entry decisions of firms in the presence of such spillovers using data on the generic drug industry. Spillovers imply that a firm’s unobserved “ability” to profit in a product market not only changes stochastically but is also is endogenous to past entry decisions. Therefore, the model needs to accommodate unobserved state variables that are endogenous to firm actions and serially correlated. We address the methodological challenge of estimating such a model using a sequential importance sampling based technique. Our estimates show significant spillover effects of entry on future profits. On average, each entry reduces costs by 7% at the next entry opportunity. On average there are eight entry opportunities annually. The average cumulative benefit of a firm that enters all eight markets in a year is 51%. We conclude that spillovers are critical in the equilibrium evolution of the structure of the generic drug industry.

Keywords: Dynamic Spillovers, Generic Pharmaceuticals, Sequential Importance Sampling, Dynamic Discrete Games, Unobserved Endogenous State Variables, Serial Correlation

JEL Classification: E00, G12, C51, C52

Suggested Citation

Gallant, A. Ronald and Hong, Han and Khwaja, Ahmed, Dynamic Entry with Cross Product Spillovers: An Application to the Generic Drug Industry (March 2010). Economic Research Initiatives at Duke (ERID) Working Paper Series No. 57. Available at SSRN: https://ssrn.com/abstract=1674027 or http://dx.doi.org/10.2139/ssrn.1674027

A. Ronald Gallant (Contact Author)

Duke University - Fuqua School of Business, Economics Group ( email )

Box 90097
Durham, NC 27708-0097
United States

New York University - Department of Economics ( email )

269 Mercer Street, 7th Floor
New York, NY 10011
United States

Han Hong

Independent

No Address Available

Ahmed Khwaja

Yale School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

Yale University - Cowles Foundation

Box 208281
New Haven, CT 06520-8281
United States

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