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Testing the Pricing-to-Market Hypothesis: Case of the Transportation Equipment Industry

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  • Lynda Khalaf
  • Maral Kichian

Abstract

Pricing-to-market (PTM) theory suggests that monopolistic firms which export adjust their destination-specific markups in reaction to exchange rate shocks. These adjustments limit changes in the price of their exports. Thus, important movements in the bilateral nominal exchange rate between two countries that trade are not necessarily fully reflected in the price of imports. Evidence in favour of PTM has been mostly obtained through hypothesis testing on the OLS, instrumental variable (IV), or single-equation error-correction estimates of partial-equilibrium models. However, we know from the recent econometric literature that Wald tests applied to some of these estimates may give erroneous results in the presence of endogeneity and weak instruments. In this paper, we examine the reliability of the evidence supporting the hypothesis of pricing-to-market using LIML-based LR Monte Carlo tests. These tests, developed by Dufour and Khalaf (1998), have good power and, unlike the Wald test, also have the correct test size. We find that the size-correct Monte Carlo LR-based test reverses half of the results obtained from the popular Wald test, indicating that PTM may not be as widespread as previously believed. In addition, our results support the view that PTM behaviour is likely to be present in the same industry across different countries and that pass-through is possibly higher with a larger market share of exports. The above findings are illustrated using the model developed by Marston (1990) and our analysis is conducted for export pricing firms in the transportation equipment industry for three country pairs: Canada exporting to the United States, the United States exporting to Canada, and Japan exporting to (mainly) the United States.

Suggested Citation

  • Lynda Khalaf & Maral Kichian, 2000. "Testing the Pricing-to-Market Hypothesis: Case of the Transportation Equipment Industry," Staff Working Papers 00-8, Bank of Canada.
  • Handle: RePEc:bca:bocawp:00-8
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    1. Jean-Jacques Chanaron, 2008. "Pricing Innovation: State of the Art and Automotive Applications," Post-Print halshs-00371047, HAL.
    2. Warmedinger, Thomas, 2004. "Import prices and pricing-to-market effects in the euro area," Working Paper Series 299, European Central Bank.

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    More about this item

    Keywords

    Econometric and statistical methods; Market structure and pricing;

    JEL classification:

    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
    • C15 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Statistical Simulation Methods: General
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • L16 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Industrial Organization and Macroeconomics; Macroeconomic Industrial Structure

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