Monday, May 25, 2015
ITO Koichiro, RIETI and Mar REGUANT, Stanford GSB theorize about Sequential Markets, Market Power and Arbitrage.
ABSTRACT: We develop a theoretical framework to characterize strategic behavior in sequential markets under imperfect competition and limited arbitrage. Our theory predicts that these two elements can generate a systematic price premium. We test the model predictions using microdata from the Iberian electricity market. We show that the observed price differences and firm behavior are consistent with the model. Finally, we quantify the welfare effects of arbitrage using a structural model. In our setting, we show that full arbitrage is not necessarily welfare-enhancing in the presence of market power. It reduces consumer costs but decreases productive efficiency.