Abstract
The aggregate Lerner index is a popular composite measure of multi-product banks’ market power, based on the assumption that banks’ single aggregate output factor is total assets. This study identifies three limitations of the aggregate Lerner index that potentially distort its interpretation as a composite measure of market power. We investigate the empirical relevance of these limitations for a sample of U.S. banks covering the years 2011–2017. We establish an economically relevant bias in the value of the aggregate Lerner index and show that this bias may also affect regressions that use the Lerner index as a dependent or explanatory variable.
Highlights
The Lerner index is a widely used measure of market power in the economic literature, whose historical and theoretical foundations have been extensively discussed in the literature (Amoroso, 1933; Lerner, 1934; Amoroso, 1938; 1954; Landes and Posner, 1981; Elzinga and Mills, 2011; Giocoli, 2012; Shaffer and Spierdijk, 2017)
We find that all three conditions are statistically rejected, which means that the aggregate Lerner index is not consistently aggregated for our sample of banks
Aggregate Lerner index In line with the literature about consistent aggregation, we find a strong relation between separability in total output of the multi-product cost function and consistent aggregation of the aggregate Lerner index
Summary
The Lerner index is a widely used measure of market power in the economic literature, whose historical and theoretical foundations have been extensively discussed in the literature (Amoroso, 1933; Lerner, 1934; Amoroso, 1938; 1954; Landes and Posner, 1981; Elzinga and Mills, 2011; Giocoli, 2012; Shaffer and Spierdijk, 2017). Despite the multi-product character of banks, the ‘aggregate’ Lerner index has remained popular in the empirical banking literature This Lerner index is based on total assets as the single aggregate output factor. Notes: This non-exhaustive table lists some recent studies (published since 2013) using aggregate, product-specific and weighted-average Lerner indices. If any of these conditions is rejected, the aggregate Lerner index is no longer consistently aggregated Because the weighted-average Lerner index is always consistently aggregated regardless of the underlying cost function, this index can be based on a cost function that fits the data well without further concerns about this cost function’s separability properties.
Sign-in/Register to view highlights & summary Sign-in/Register to access full text options 
Free) 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a call
