An Internally Consistent Approach to the Estimation of Market Power and Cost Efficiency with an Application to U.S. Banking

European Journal of Operational Research, 2018

26 Pages Posted: 27 Apr 2018

See all articles by Efthymios G. Tsionas

Efthymios G. Tsionas

Athens University of Economics and Business - Department of Economics

Emir Malikov

University of Nevada, Las Vegas

Subal C. Kumbhakar

State University of New York (SUNY) at Binghamton - Department of Economics

Date Written: April 9, 2018

Abstract

We develop a novel unified econometric methodology for the formal examination of the market power -- cost efficiency nexus. Our approach can meaningfully accommodate a mutually dependent relationship between the firm's cost efficiency and marker power (as measured by the Lerner index) by explicitly modeling the simultaneous determination of the two in a system of nonlinear equations consisting of the firm's cost frontier and the revenue-to-cost ratio equation derived from its stochastic revenue function. Our framework places no a priori restrictions on the sign of the dependence between the firm's market power and efficiency as well as allows for different hierarchical orderings between the two, enabling us to discriminate between competing quiet life and efficient structure hypotheses. Among other benefits, our approach completely obviates the need for second-stage regressions of the cost efficiency estimates on the constructed market power measures which, while widely prevalent in the literature, suffer from multiple econometric problems as well as lack internal consistency/validity. We showcase our methodology by applying it to a panel of U.S. commercial banks in 1984-2007 using Bayesian MCMC methods.

Keywords: Productivity, Competitiveness, Efficiency, Market Power, Lerner Index, Banks, Quiet Life Hypothesis

JEL Classification: C11, C30, D24, D40, G21

Suggested Citation

Tsionas, Efthymios (Efthymios) G. and Malikov, Emir and Kumbhakar, Subal C., An Internally Consistent Approach to the Estimation of Market Power and Cost Efficiency with an Application to U.S. Banking (April 9, 2018). European Journal of Operational Research, 2018, Available at SSRN: https://ssrn.com/abstract=3159600

Efthymios (Efthymios) G. Tsionas

Athens University of Economics and Business - Department of Economics ( email )

76 Patission Street
GR-10434 Athens
Greece
+301 8203 (Phone)
+301 8203 301 (Fax)

Emir Malikov (Contact Author)

University of Nevada, Las Vegas ( email )

4505 S. Maryland Parkway
Las Vegas, NV 89154
United States

Subal C. Kumbhakar

State University of New York (SUNY) at Binghamton - Department of Economics ( email )

Binghamton, NY 13902-6000
United States

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