Nonlinear Pricing with Competition: The Market for Settling Payments

38 Pages Posted: 16 Aug 2015

See all articles by Adam M. Copeland

Adam M. Copeland

Federal Reserve Bank of New York

Rodney Garratt

Federal Reserve Banks - Federal Reserve Bank of New York

Date Written: August 1, 2015

Abstract

The multiple payments settlement systems available in the United States differ on several dimensions. The Fedwire Funds Service, a utility that operates a U.S. large-value payments-settlement service, offers the fastest speed of settlement. Recognizing that payments differ in the urgency with which they need to be settled, Fedwire offers banks a decreasing block-price schedule. This approach allows Fedwire to price discriminate, charging high fees for urgent payments and low fees for less urgent ones. We analyze banks’ demand for Fedwire Funds given this nonlinear scheme, taking into account competing settlement systems. We show that how banks respond to Fedwire’s pricing depends crucially on the need to settle payments quickly. If the urgency for immediate settlement is great enough, banks will respond to marginal price; otherwise, they will respond to average price. We test whether banks respond to marginal or to average price. Our identification comes from exogenous variation in Fedwire’s pricing, which results in differential changes in marginal and average price for comparable banks. We find that banks respond to average price.

Keywords: nonlinear pricing, marginal versus average pricing

JEL Classification: L11, L51, L97, E42

Suggested Citation

Copeland, Adam M. and Garratt, Rodney, Nonlinear Pricing with Competition: The Market for Settling Payments (August 1, 2015). FRB of New York Staff Report No. 737, Available at SSRN: https://ssrn.com/abstract=2644601 or http://dx.doi.org/10.2139/ssrn.2644601

Adam M. Copeland (Contact Author)

Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

Rodney Garratt

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

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