Positive expectations feedback experiments and number guessing games as models of financial markets (revised version of WP 08-07)

In repeated number guessing games choices typically converge quickly to the Nash equilibrium. In positive expectations feedback experiments, however, convergence to the equilibrium price tends to be very slow, if it occurs at all. Both types of experimental designs have been suggested as modeling essential aspects of financial markets. In order to isolate the source of the differences in outcomes we present several new treatments in this paper. We conclude that the feedback strength (i.e. the ‘p-value’ in standard number guessing games) is essential for the results. Furthermore, positive expectations feedback experiments may provide good representations of highly speculative markets while standard number guessing games model financial markets with more emphasis on dividend yield and value stocks.

Imperfect Competition Law Enforcement

Competition policy is a subject of often heated debate. Competition authorities, seeking to battle anticompetitive acts in complex cases to the best of their abilities, regularly find themselves advised by rival economic theories and disputed empirical analyses. As a consequence, there is a real possibility that they may occasionally err, missing true violations of competition law or finding firms liable that have actually done nothing but good competition. In this paper, possible consequences of such imperfect competition law enforcement on firm strategies are considered. In a simple cartel setting, it is found that the incidence of anti-competitive behavior increases in both types of enforcement errors: Type II errors decrease expected fines, while Type I errors encourage industries to collude precautionary when they face the risk of false allegations. Hence, fallible antitrust enforcement may stifle genuine competition. Moreover, when enforcement error are non-negligible, competition authorities run the risk of being over-zealous, in the sense that welfare is best served by an authority that is selective in its targeting of alleged anticompetitive acts.

A class of evolutionary model for participation games with negative feedback (revised version of WP 06-10)

We introduce a framework to analyze the interaction of boundedly rational heterogeneous agents repeatedly playing a participation game with negative feedback. We assume that agents use different behavioral rules prescribing how to play the game conditionally on the outcome of previous rounds. We update the fraction of the population using each rule by means of a general class of evolutionary dynamics based on imitation, which contains both replicator and logit dynamics. Our model is analyzed by a combination of formal analysis and numerical simulations and is able to replicate results from the experimental and computational literature on these types of games. In particular, irrespective of the specific evolutionary dynamics and of the exact behavioral rules used, the dynamics of the aggregate participation rate is consistent with the symmetric mixed strategy Nash equilibrium, whereas individual behavior clearly departs from it. Moreover, as the number of players increases the evolutionary dynamics typically becomes unstable and leads to endogenous fluctuations around the steady state. These fluctuations are robust with respect to behavioral rules that try to exploit them.

Forced Freebies: A Note on Partial Deregulation with Pro Bono Supply Requirements

The liberalization of many former state governed natural monopolies in sectors such as electricity, railroad and telecommunications is done by partial deregulation. Typically, entry is invited into elements of the production chain, yet under strict price and quality controls. This note considers some potential welfare effects of an unconventional type of conditional deregulation, used in the electricity market in Flanders, Belgium, where the utility companies are held to deliver the households they supply a complimentary basic electricity package free of charge. It is shown that, while decreasing the number of new entrants into the liberalized market, such pro bono supply requirements can nevertheless increase net total production. A general condition for a welfare maximizing level of `forced freebies' is derived.

On Learning Equilibria (Revised June 2003)

We investigate an inflationary overlapping generations model where households predict future inflation rates by running a least squares regression of inflation rates or prices on their past levels. We critically examine the results on learning equilibria obtained by Bullard (1994) and Schönhofer (1999) in this framework. They show that an increase in the money growth rate may lead to limit cycles and endogenous business cycles. We suggest an alternative estimation procedure, that starts from the same perceived law of motion, but is more sensible from an econometrician's point of view. We prove that for this estimation procedure there is global convergence on the monetary steady for a large set of savings functions. We also study, in a heterogeneou agents framework, evolutionary competition between the two estimation procedures, where the fraction of the population using a certain estimation procedure is determined by its past average quadratic forecast error. Interestingly, the more sensible estimation procedure is not always able to drive out the other estimation procedure, and endogenous business cycles may still be observed in this heterogeneous world.

Illinois Walls in alternative market structures

This note extends on our paper Illinois Walls: How barring indirect purchaser suits facilitates collusion (Schinkel, Tuinstra and Rüggeberg, 2005, henceforth STR). It presents analyses of two alternative, more competitive, market structures to conclude that when the conditions for existence of Illinois Walls derived in STR are satisfied, Illinois Walls also exist in these alternative market structures. Section 1 considers a market in which each downstream firm is able to buy and sell several varieties of the differentiated product, which increases competition at the downstream level. It is found that Illinois Walls then exist for discount factors higher than a certain critical discount factor, where this critical discount factor is strictly smaller than the critical discount value found in STR. Section 2 studies the case where all wholesalers produce one and the same homogeneous input, which the downstream firms each differentiate into their own variety. In this market structure, competition is strong at the upstream level. Illinois Walls turn out to exist for any positive value of the discount factor. These findings suggest that Illinois Walls are robust to variations in market structure.

Illinois Walls

In its landmark ruling in Illinois Brick Co. v. Illinois, the U.S. Supreme Court restricted the right to sue for private damages suffered from violations of section 4 of the Clayton Act to direct purchasers. Despite the fact that typically antitrust injury is, at least in part, passed on to firms lower in the production chain and ultimately to consumers, Illinois Brick has since stood as a binding legal constraint. This paper considers the strategic use that upstream firms can make of Illinoi Brick to shield themselves from private damages claims. In a repeated game setting, we find that Illinois Brick may facilitate upstream firms in engaging horizontally in an overt collusive arrangement, with concealed side-payments to their direct purchasers that discourage them from filing suit. An example is given of such an `Illinois Wall', in which downstream firms are given part of the upstream cartel profits through a symmetric rationing of their inputs at low prices. The Illinois Wall is found to be resilient to entry, imperfections of the legal system and leniency programs. In fact, the wall is particularly stable when competition is relatively strong at both the up- and the downstream level.

Illinois Walls: How barring indirect purchaser suits facilitates collusion

In its landmark ruling in Illinois Brick Co. v. Illinois, the U.S. Supreme Court restricted standing to sue for recovery of damages suffered from a breach of federal antitrust law to direct purchasers only. Even though typically antitrust injury is, at least in part, passed on to firms lower in the production chain and ultimately to consumers, Illinois Brick is binding precedent in a majority of states. In this paper, we draw attention to a strategic abuse of the rule as a shield against antitrust damages claims. We show that Illinois Brick facilitates upstream firms in engaging horizontally in a collusive arrangement, allowing them to focus concealed vertical side-payments to discourage civil action on their direct purchasers only. Downstream firms are passed part of the upstream cartel profits through a symmetric rationing of their inputs at low prices. This `Illinois Wall' arrangement sustains collusion in the production chain to the detriment of consumers and reducing total welfare. The more competitive the up- and downstream industries otherwise are, the more scope there is for the arrangement. Illinois Walls are shown to be resilient to entry, as well as to variations in the legal system. Several recent U.S. cartel cases display some of their symptoms, suggesting that the abuse of Illinois Brick is a reality in U.S. industry.

Quantifying the Scope for Efficiency Defense in Merger Control: The Werden-Froeb-Index

In both US and EU merger control, merger-specific efficiencies are recognized as a possible defense for horizontal mergers that raise competition concerns. We introduce the Werden-Froeb-index (WFI) to assist in evaluating these efficiencies. The index measures the average reduction in marginal costs required to restore pre-merger equilibrium prices and quantities after the merger is consummated. It has low information requirements and can deal with any number of firms in price- or quantity-competition merging fully or partially, and a large class of demand and cost functions. We show how the WFI complements Phase I merger inquiries as a screening mechanism.