Estimating Market Power in Homogenous Product Markets Using a Composed Error Model: Application to the California Electricity Market

26 Pages Posted: 22 Feb 2018  

Luis Orea

Universidad de Oviedo - Facultad de Economicas

Jevgenijs Steinbuks

World Bank - Development Research Group (DECRG)

Date Written: April 2018

Abstract

This study proposes a novel econometric approach to estimating market power in homogenous product markets. We use a composed error model to estimate the stochastic part of firms' strategic pricing equation. This part is formed by two random variables: a traditional error term, which captures random shocks, and a random conduct term, which measures the degree of market power. This approach allows for the conduct parameter to vary flexibly across firms and within firms over time, and avoids ad hoc structural restrictions for identifying firms' conduct. The empirical application of our approach is based on a well‐known California wholesale electricity market data set, which has been rigorously used to study market power. Our results suggest that realization of market power varies over both time and firms, and reject the assumption of a common or time‐invariant conduct parameter.

JEL Classification: C34, C51, L13, L94

Suggested Citation

Orea, Luis and Steinbuks, Jevgenijs, Estimating Market Power in Homogenous Product Markets Using a Composed Error Model: Application to the California Electricity Market (April 2018). Economic Inquiry, Vol. 56, Issue 2, pp. 1296-1321, 2018. Available at SSRN: https://ssrn.com/abstract=3127905 or http://dx.doi.org/10.1111/ecin.12539

Luis Orea (Contact Author)

Universidad de Oviedo - Facultad de Economicas ( email )

Campus del Cristo
Oviedo, Asturias 33071
Spain

Jevgenijs Steinbuks

World Bank - Development Research Group (DECRG) ( email )

1818 H. Street, N.W.
MSN3-311
Washington, DC 20433
United States

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