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

Mike Tsionas, Emir Malikov () and Subal Kumbhakar ()

MPRA Paper from University Library of Munich, Germany

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 (search for similar items in EconPapers)
JEL-codes: C11 C30 D24 D40 G21 (search for similar items in EconPapers)
Date: 2018
New Economics Papers: this item is included in nep-ban, nep-com, nep-ecm, nep-eff and nep-ore
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Journal Article: An internally consistent approach to the estimation of market power and cost efficiency with an application to U.S. banking (2018) Downloads
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