Keywords: Non-nested hypothesis testing, bank competition, market definition
Abstract: This paper introduces a simple method to test between two general approaches to defining bank and
thrift product markets. I estimate two models that endogenize market structure using data on banks
and thrifts from 1,884 rural markets for the year 2000. The first model assumes that banks and
thrifts are in "independent product markets," i.e., that bank profitability depends only on
competition from other banks and that thrift profitability depends only on competition from
other thrifts. An alternative model is then estimated assuming that banks and thrifts are
"perfect strategic substitutes," i.e., that a bank's equilibrium profitability falls equally
with the presence of another bank or an additional thrift (and vice-versa). A transformation
of the likelihood for the "independent markets" model allows me to test it against the
"perfect strategic substitutes" model using Vuong's (1989) non-nested likelihood ratio test.
The hypothesis that banks and thrifts compete in independent product markets is soundly
rejected against the hypothesis that banks and thrifts are perfect strategic substitutes.
Full paper (271 KB PDF)
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Last update: January 29, 2004