Advertisement

Simulation-Based Tests of PTM

  • Lynda Khalaf
  • Maral Kichian
Part of the Applied Optimization book series (APOP, volume 74)

Abstract

Pricing-to-market (PTM) theory stipulates that exporting monopolistic firms set different prices for their goods depending on the destination markets. In other words, firms adjust their destination-specific markup in order to conform to differing demand characteristics in each country and to account for bilateral exchange rate fluctuations that could potentially affect the demand for their goods.

Empirical support for PTM comes mostly from ordinary least squares and instrumental variable (IV) estimations of partial equilibrium models. Unfortunately, this evidence may be spurious. Indeed, it was recently shown that standard inference methods in instrumental regressions (including exogeneity tests and Wald tests on regression coefficients) are highly unreliable, particularly when the instruments at hand are uninformative.

This study revisits the PTM evidence on various Japanese manufacturing product groups and industries, taking the above concerns explicitly into account. Exogeneity tests, as well as bounds and bootstrap-type likelihood ratio tests, are therefore carried out, based on OLS and limited-information maximum likelihood estimates of the well-known PTM model developed by Marston (1990). Unlike the standard IV-based procedures, these tests are known to achieve level control even when instruments are weak.

Results reveal significant right-hand-side endogeneity in the examined PTM equations. Furthermore, whereas statistical tests which ignore this problem (i.e. which replicate Marston’s testing strategy) overwhelmingly reject the no PTM null, the tests which properly correct for endogeneity fail to reject this null for several industries. This suggests that available partial-equilibrium-based evidence in favor of PTM may not be as statistically conclusive as was previously believed.

Keywords

pricing-to-market simulation-based inference weak instruments 

Preview

Unable to display preview. Download preview PDF.

Unable to display preview. Download preview PDF.

References

  1. Bergin, P., and R.C. Feenstra. (1999). “Pricing-to-Market, Staggered Contracts and Real Exchange Rate Persistence”, NBER Working Paper 7026.Google Scholar
  2. Betts, C. and M. Devereux. (1996). “The Exchange Rate in a Model of Pricing-to-Market”, European Economic Review, 40: 1007–21.CrossRefGoogle Scholar
  3. Betts, C. and M. Devereux. (1998). “Exchange Rate Dynamics in a Model of Pricing-to-Market”, discussion paper, University of British Columbia.Google Scholar
  4. Betts, C. and M. Devereux. (2000). “The International Effects of Monetary and Fiscal Policy in a Two-Country Model”, Calvo, G.A., Dornbusch, R., Obstfeld, M., editors, Money, Capital Mobility and Trade: Essays in Honor of Robert A. Mundell. MIT Press, Cambridge, MA.Google Scholar
  5. Campa, J. M. and L. Goldberg. (1999). “Investment, Pass-Through, and Exchange Rates: A Cross-Country Comparison”, International Economic Review, 40: 287–314.CrossRefGoogle Scholar
  6. Cheung, Y. W. and M. Chinn. (1999). “Market Structure and the Persistence of Sectoral Real Exchange Rates”, NBER Working Paper No. 7408.Google Scholar
  7. Dufour, J.M. (1987). “Linear Wald Methods for Inference on Covariance Matrices and Weak Exogeneity Tests in Structural Equations”, Time Series and Econometric Modelling, I.B. MacNeil and G.J. Umphrey, editors, D. Reidel Publishing Company, 317–338.CrossRefGoogle Scholar
  8. Dufour, J.M. (1995). “Monte Carlo Tests in the Presence of Nuisance Parameters, with Econometric Applications”, working paper, C.R.D.E., Université de Montréal.Google Scholar
  9. Dufour, J.M. (1997). “Some Impossibility Theorems in Econometrics with Applications to Structural and Dynamic Models”, Econometrica 65: 1365–88.CrossRefGoogle Scholar
  10. Dufour J.-M. and L. Khalaf. (1998). “Simulation Based Finite and Large Sample Inference Methods in Simultaneous Equations”, discussion paper, C.R.D.E., Université de Montréal and GREEN, Université Laval.Google Scholar
  11. Dufour J.-M. and L. Khalaf. (2001). “Monte Carlo Tests Methods in Econometrics”, Baltagi B., editor, Companion to Theoretical Econometrics, Blackwell, Oxford, UK.Google Scholar
  12. Faruqee, H. (1995). “Pricing-to-Market and the Real Exchange Rate”, IMF Staff Papers 42: 855–881.CrossRefGoogle Scholar
  13. Feenstra, R.C. (1989). “Symmetric Pass-Through of Tariffs and Exchange Rates Under Imperfect Competition: An Empirical Test”, Journal of International Economics 27: 25–45.CrossRefGoogle Scholar
  14. Feenstra, R.C., Gagnon, J. and M. Knetter. (1996). “Market Share and Exchange Rate Pass-Through in World Automobile Trade”, Journal of International Economics 40: 187–207.CrossRefGoogle Scholar
  15. Feenstra, R.C. and J.D. Kendall. (1997). “Pass-through of exchange rates and purchasing power parity”, Journal of International Economics 43: 237–61.CrossRefGoogle Scholar
  16. Gagnon, J. and M. Knetter. (1995). “Mark-up Adjustment and Exchange Rate Fluctuations: Evidence from Panel Data on automobile Exports”, Journal of International Money and Finance 14: 289–310.CrossRefGoogle Scholar
  17. Giovannini, A. (1988). “Exchange Rates and Traded Goods Prices”, Journal of International Economics 24: 45–68.CrossRefGoogle Scholar
  18. Goldberg, P.K. and M. Knetter. (1997). “Goods Prices and Exchange Rates: What Have We Learned?”, Journal of Economic Literature 35: 1243–1272.Google Scholar
  19. Kasa, K. (1992). “Adjustment Costs and Pricing-to-Market”, Journal of International Economics 30: 1–30.CrossRefGoogle Scholar
  20. Khalaf, L. and M. Kichian. (2000). “Testing the Pricing-to-Market Hypothesis; Case of the Transportation Industry”, Bank of Canada working paper 2000–8.Google Scholar
  21. Klitgaard, T. (1999). “Exchange Rates and Profit Margins: The Case of Japanese Exporters”, FRBNY Economic Policy Review, 41–54.Google Scholar
  22. Knetter, M. (1993). “International Comparisons of Pricing-to-Market Behavior”, American Economic Review 83: 473–486.Google Scholar
  23. Krugman, P. (1987). “Pricing-to-Market When the Exchange Rate Changes”, Real financial Linkages Among Open Economies, Arndt, S.W. and Richardson, J.D., editors, MIT Press, Cambridge, MA.Google Scholar
  24. Marston, R. (1990). “Pricing To Market in Japanese Manufacturing”, Journal of International Economics 29: 217–237.CrossRefGoogle Scholar
  25. Obstfeld, M. and K. Rogoff, (1995). “Exchange Rate Dynamics Redux”, Journal of Political Economy 103: 624–60.CrossRefGoogle Scholar
  26. Obstfeld, M. and K. Rogoff, (1999). “New Directions for Stochastic Open Economy Models”, NBER Working Paper no. 7313.Google Scholar
  27. Staiger, D. and J. H. Stock, (1997), “Instrumental Variables Regression with Weak Instruments”, Econometrica 65: 557–586.CrossRefGoogle Scholar
  28. Wang, J. and E. Zivot, (1998), “Inference on Structural Parameters in Instrumental Variables Regression with Weak Instruments”, Econometrica 66: 1389–1404.CrossRefGoogle Scholar

Copyright information

© Springer Science+Business Media Dordrecht 2002

Authors and Affiliations

  • Lynda Khalaf
    • 1
    • 2
  • Maral Kichian
    • 3
  1. 1.GREEN, Département d’économiqueUniversité LavalQuébecCanada
  2. 2.C.R.D.E.Université de MontréalQuébecCanada
  3. 3.Research DepartmentBank of CanadaOttawaCanada

Personalised recommendations