An internally consistent approach to the estimation of market power and cost efficiency with an application to U.S. banking

Tsionas, Efthymios G. and Malikov, Emir and Kumbhakar, Subal C. (2018) An internally consistent approach to the estimation of market power and cost efficiency with an application to U.S. banking. European Journal of Operational Research, 270 (2). pp. 747-760. ISSN 0377-2217

PDF (TsionasMalikovKumbhakar-Jan2018-MarketPowerEfficiency)
TsionasMalikovKumbhakar_Jan2018_MarketPowerEfficiency.pdf - Accepted Version
Available under License Creative Commons Attribution Non-commercial No Derivatives.

Download (1MB)


We develop a novel unified econometric methodology for the formal examination of the market power – cost efficiency nexus. Our approach can meaningfully accommodate a mutually dependent relationship between the firm’s cost efficiency and marker power (as measured by the Lerner index) by explicitly modeling the simultaneous determination of the two in a system of nonlinear equations consisting of the firm’s cost frontier and the revenue-to-cost ratio equation derived from its stochastic revenue function. Our framework places no a priori restrictions on the sign of the dependence between the firm’s market power and efficiency as well as allows for different hierarchical orderings between the two, enabling us to discriminate between competing quiet life and efficient structure hypotheses. Among other benefits, our approach completely obviates the need for second-stage regressions of the cost efficiency estimates on the constructed market power measures which, while widely prevalent in the literature, suffer from multiple econometric problems as well as lack internal consistency/validity. We showcase our methodology by applying it to a panel of U.S. commercial banks in 1984–2007 using Bayesian MCMC methods.

Item Type:
Journal Article
Journal or Publication Title:
European Journal of Operational Research
Additional Information:
This is the author’s version of a work that was accepted for publication in European Journal of Operational Research. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. A definitive version was subsequently published in European Journal of Operational Research, 270, 2, 2018 DOI: 10.1016/j.ejor.2018.04.012
Uncontrolled Keywords:
ID Code:
Deposited By:
Deposited On:
14 Sep 2018 08:30
Last Modified:
17 Sep 2023 02:21