Research output: Nonlinear Cointegration and Relevant Market Definition:A Study of Grocery Markets


(Coinvestigated by Dr. LEE Shu Kam, Dr. WOO Kai Yin and Dr. SHUM, Paul Kwok-ching)

This research project is supported under the Faculty Development Scheme of the Research Grants Council. Dr. LEE Shu Kam, Associate Professor, Department of Economics and Finance, is the Principal Investigator of the project.

Dr. LEE Shu Kam

The grocery industry in Hong Kong has increased its concentration over the last three decades. High concentration may give rise to market power, which in turn causes anti-competitive behaviours and high grocery prices. But based on the theory of contestable markets, high concentration may not necessarily result in excessive market power. In his study, Dr. LEE and his research team finds the existence of price co-movement in Hong Kong grocery market is unlikely due to collusion but market competition, and the benefit of one-stop grocery shopping in supermarket chains can lower transaction costs (including the costs of time spent, search and transportation) and out-weight the higher prices.

In an interview with Shue Yan Newsletter, Dr. LEE said that the main objective of his study is to determine whether competition in the Hong Kong grocery industry is fit and proper by proposing a set of nonlinear price-based cointegration tests that take transaction costs into account to increase the precision of anti-competition decision making.

To assess the degree of competition in the grocery industry, the common approach in the competition policy literature is to first define the relevant market, which identifies all substitutes that are competing in the market. Fewer substitutes reflect a lack of competition where sub-optimal productive and allocative efficiency would likely occur as a result. Competition authorities in foreign countries have recognised the usefulness of econometric cointegration tests in defining the relevant market and have used the test results to support policy and court decisions.

However, according to Dr. LEE, the standard cointegration tests previously adopted by the anti-competition research studies do not consider transaction costs. The existence of these transaction costs are however important because if the potential gain from price differentials of similar products does not outweigh the transaction costs, the arbitrage process to equalize the two product prices will not take place. Hence, when the effects of transaction costs are ignored in the standard cointegration tests, though these two similar products are competing fiercely in a fit and proper competitive market and their prices synchronize closely, the testing results may still mistakenly conclude that these two products are not competitive substitutes. Their  study overcomes this weakness of the previous studies by embedding the transaction costs into nonlinear price-based cointegration tests. Most importantly, the standard cointegration tests cannot distinguish whether the price co-movement is attributable to market competition or collusion. They argue that price co-movements may not necessarily imply price competition but may be due to price collusion. Compared with market competition, prices under collusion would exhibit downward price rigidity but quicker upward price adjustment.

After analyzing data on the price indices of supermarket chains and non-supermarkets from January 1999 to December 2014, Dr. LEE and his team found the empirical evidence of mutual competition to cut prices, rather than collusion to raise prices in the Hong Kong grocery industry. It indicates that despite the large market concentration of the supermarket sectors, the grocery industry as a whole is competitive.

“I am happy that we have developed a set of nonlinear price-based cointegration tests that take transaction costs into account and can be used to increase the precision of anti-competition decisions.” Dr. LEE said.

Source: April Issue 2018

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