Price Adjustment Process Research Articles

The Pricing Behaviour of Firms in the Euro Area: New Survey Evidence

This study investigates the pricing behaviour of firms in the euro area on the basis of surveys conducted by nine Eurosystem national central banks. Overall, more than 11,000 firms participated in the survey. The results are very robust across countries. Firms operate in monopolistically competitive markets, where prices are mostly set following mark-up rules and where price discrimination is a common practice. Our evidence suggests that both time- and state-dependent pricing strategies are applied by firms in the euro area: around one-third of the companies follow mainly time-dependent pricing rules while two-thirds use pricing rules with some element of state-dependence. Although the majority of firms take into account a wide range of information, including past and expected economic developments, about one-third adopts a purely backward-looking behaviour. The pattern of results lends support to the recent wave of estimations of hybrid versions of the New Keynesian Phillips Curve. Price stickiness arises both at the stage when firms review their prices and again when they actually change prices. The most relevant factors underlying price rigidity are customer relationships – as expressed in the theories about explicit and implicit contracts – and thus, are mainly found at the price changing (second) stage of the price adjustment process. Finally, we provide evidence that firms adjust prices asymmetrically in response to shocks, depending on the direction of the adjustment and the source of the shock: while cost shocks have a greater impact when prices have to be raised than when they have to be reduced, reductions in demand are more likely to induce a price change than increases in demand.

Information Transmission and Adjustment Process during Speculative Bubbles: Indian and US Markets during Technology Bubble

It is widely accepted that speculative bubbles lead to prolonged deviations in the securities prices from their intrinsic values. Stock mispricing due to such deviations may not only lead to adverse wealth effects for the investors but also towards overall economic stability of the economy. However, it is not clear whether the level and magnitude of mispricing varies across economies for a particular economic event. The Technology bubble formation during the late Nineties, and its subsequent deflation during the early Twenties, provides an opportunity to examine the information transmission, adjustment and the extent of mispricing across different economies. This paper addresses these issues using Variance Decomposition and, Impulse Response methodology provided by Sims (1980) and Corrected Damodaran (1993) methodology. We find differences in price adjustment process in the two markets; for instance, we find that it takes a longer period for information adjustment in the Indian Technology equity market compared with US Technology equities. Also, Indian stocks on average overreact to information arrival where as US stocks on average underreact to information arrival. Interestingly, we find that the US and the Indian technology markets were not cointegrated over the observations period and that the US market led the Indian market in the price discovery process in all periods except during the bubble formation period. Finally, this paper reports specific aspects of firm characteristics-based portfolios in both markets. Overall we find that the US market has a faster recovery mechanism than the Indian market.

A PRICE ADJUSTMENT PROCESS IN A MODEL OF MONOPOLISTIC COMPETITION

We consider a price adjustment process in a model of monopolistic competition. Firms have incomplete information about the demand structure. When they set a price they observe the amount they can sell at that price and they observe the slope of the true demand curve at that price. With this information they estimate a linear demand curve. Given this estimate of the demand curve they set a new optimal price. We investigate the dynamical properties of this learning process. We find that, if the cross-price effects and the curvature of the demand curve are small, prices converge to the Bertrand-Nash equilibrium. The global dynamics of this adjustment process are analyzed by numerical simulations. By means of computational techniques and by applying results from homoclinic bifurcation theory we provide evidence for the existence of strange attractors.

Shattering the Myth of Costless Price Changes: Emerging Perspectives on Dynamic Pricing

In this paper, we argue that pricing is all about price changes, and that the costs of price changes are often simultaneously subtle and substantial. We discuss a framework to deal with the dynamics of changing prices. This framework incorporates customer interpretations of price changes, an awareness of the organizational costs of price changes, investments in future pricing processes, and an understanding of the role that supply chains play in price change strategy. The framework can be used at the tactical level to improve the specific price changes chosen and made, at the managerial level to decide whether or not to make a particular price change at all, and at the strategic level to determine what price adjustment processes should be invested in to improve pricing effectiveness in the future.

Exchange rate regimes and the real sector: a sectoral analysis of CEE Countries

This article analyses the impact of exchange rate regimes on the real sector. While most studies in this field have so far concentrated on aggregate variables, we pursue a sectoral approach distinguishing between the tradable and non-tradable sectors. First, we present a survey of the relevant theoretical and empirical literature. This demonstrates that evaluations of exchange rate regimes and their impact on the real economy are largely dependent on specific assumptions concerning, in particular, the parameters of a utility function, the nature of the price adjustment process and the characteristics of the shocks analysed. Second, we conduct an empirical analysis of the behaviour of the tradable and non-tradable sectors under different exchange rate regimes in seven Central and Eastern European countries. We find no firm evidence of a differential impact of given exchange rate regimes on the dynamics of output and prices in the two sectors. We proffer a conceptual and technical interpretation of this.

Strategic Trading, Liquidity, and Information Acquisition

We study endogenous liquidity trading in a market with long-lived asymmetric information. We distinguish between public information, tractable information that can be acquired, and intractable information that cannot be acquired. Besides information asymmetry and noise, the adverse-selection spread depends on the diffusion of intractable information and on the interest rate. With endogenous liquidity trading, efficiency is lower than that implied by noise-trading models. Liquidity traders benefit from the information released through the insider's trades in spite of their monetary losses. We study factors that affect the insider's information acquisition decision, including the amount of intractable information, observability, and information acquisition costs. Providing liquidity to investors who want to exchange financial assets for cash or vice versa without possessing superior information is a key role of financial markets [Amihud and Mendelson (1986), Grossman and Miller (1988)]. The choice problem faced by such liquidity traders and its effects on market performance are often overlooked in dynamic models of asymmetric information in financial markets. In this article, liquidity traders endogenously determine the quantities they trade, taking information asymmetry and asset riskiness into account. We study the effect of endogenous liquidity trading on market performance and on the informed trader's incentives to acquire information and to release it to the market. We propose a tractable model of endogenous liquidity trading and derive its equilibrium in closed form. The results enable us to make qualitative and quantitative predictions on the effects of different types of information on liquidity, efficiency, and welfare. We also formulate testable implications regarding the determinants of the spread, the nature of the price-adjustment process, and the effects of changes in the investor

Walrasian equilibrium in an exchange economy with indivisibilities

This paper studies an exchange economy with indivisibilities. Our main goal is to see if a price system can function well in an economy (e.g., an economy with complementary preferences) that does not have a Walrasian equilibrium. We study the price-adjustment processes governed by the Euler iterative scheme. We show that, in an economy that has a Walrasian equilibrium, our price-adjustment processes have a common uniform limit that is unique and converges to a Walrasian equilibrium price vector in finite time. Surprisingly, in an economy that does not have a Walrasian equilibrium, our price-adjustment processes also have a common uniform limit that is unique and converges to an equilibrium in the convexified economy in finite time. Moreover, equilibrium prices in the convexified economy coincide with Walrasian equilibrium prices in an economy that has a Walrasian equilibrium. Further, there are no other prices that have such a property of global stability.

Global instability in experimental general equilibrium: the scarf example

Scarf (1960) proposed a market environment and a model of dynamic adjustment in which the standard tatonnement price adjustment process orbits around, rather than converges to, the competitive equilibrium. Hirota (1981) characterized the price paths by the configuration of endowments. We explore the predictions of Scarf's model in a nontatonnement experimental double auction. We find that the average transaction prices in each period do follow the path predicted by the Scarf and Hirota models. When the model predicts prices will converge to the competitive equilibrium, our data converge; when the model predicts prices will orbit our data orbit the equilibrium, and in the direction predicted by the model. Moreover, we observe a weak tendency for prices within a period to follow the path predicted by the model.

Exchange Rate Regimes and the Real Sector: A Sectoral Analysis of CEE Countries

This paper analyses the impact of exchange rate regimes on the real sector. While most studies in this field have so far concentrated on aggregate variables, we pursue a sectoral approach distinguishing between the tradable and nontradable sectors. Firstly, we present a survey of the relevant theoretical and empirical literature. This demonstrates that evaluations of exchange rate regimes and their impact on the real economy are largely dependant on specific assumptions concerning, in particular, the parameters of a utility function, the nature of the price adjustment process and the characteristics of analysed shocks. Secondly, we conduct an empirical analysis of the behaviour of the tradable and nontradable sectors under different exchange rate regimes for seven Central and Eastern European countries. We find no firm evidence of a differential impact of given exchange rate regimes on the dynamics of output and prices in the two sectors. We proffer a conceptual and technical interpretation of this.

Let it be: chaotic price instability can be beneficial

This study investigates an economic implication of chaotic fluctuations generated by a discrete price adjustment process. For this purpose, it uses a pure exchange model with two goods and two consumers in which chaotic price fluctuations can arise. In order to reveal some statistical properties of such price dynamics, this study constructs a density function of chaotic trajectory, calculates a long-run average utility, and then compares it with the utility corresponding to a stationary state. The following two results are analytically as well as numerically demonstrated: (1) chaotic price dynamics can be beneficial for one consumer and harmful to the other consumer and (2) the whole economy is possibly better off along chaotic fluctuations than at a stationary state in the long-run. Further, it is shown that the second result is sensitive to the social judgement on the ranking of consumers’ utilities. These results imply the possibility that chaotic fluctuations can be preferable to a stationary state.

Analyst Forecast Revisions and Market Price Discovery

We document several factors that help explain cross-sectional variations in the post-revision price drift associated with analyst forecast revisions. First, the market does not make a sufficient distinction between revisions that provide new information (“high-innovation” revisions) and revisions that merely move toward the consensus (“low-innovation” revisions). Second, the price adjustment process is faster and more complete for “celebrity” analysts (Institutional Investor All-Stars) than for more obscure yet highly accurate analysts (Wall Street Journal Earnings-Estimators). Third, controlling for other factors, the price adjustment process is faster and more complete for firms with greater analyst coverage. Finally, a substantial portion of the delayed price adjustment occurs around subsequent earnings-announcement and forecast-revision dates. Collectively, these findings show that more subtle aspects of an earnings revision signal can hinder the efficacy of market price discovery, particularly in firms with relatively low analyst coverage, and that subsequent earnings-related news events serve as catalysts in the price discovery process.

Globally stable price dynamics

It is known that the price mechanism whereby the rate of change of a price is proportional to the excess demand of the corresponding commodity need not converge to a competitive equilibrium for a pure exchange economy with more than two commodities. In this paper, conditions for the excess demand, guaranteeing the existence of some price adjustment process, which is globally asymptotically stable and fulfils reasonable compatibility condition with the excess demand, are given.

Market efficiency and accounting research: a discussion of ‘capital market research in accounting’ by S.P. Kothari

Much of capital market research in accounting over the past 20 years has assumed that the price adjustment process to information is instantaneous and/or trivial. This assumption has had an enormous influence on the way we select research topics, design empirical tests, and interpret research findings. In this discussion, I argue that price discovery is a complex process, deserving of more attention. I highlight significant problems associated with a naı̈ve view of market efficiency, and advocate a more general model involving noise traders. Finally, I discuss the implications of recent evidence against market efficiency for future research.

Market Efficiency and Accounting Research: A Discussion of 'Capital Market Research in Accounting' by S.P. Kothari

Much of capital market research in accounting over the past 20 years has assumed that the price adjustment process to information is instantaneous and/or trivial. This basic assumption has had an enormous influence on the way we select research topics, design empirical tests, and interpret research findings. In this discussion, I argue that price discovery is a complex process, deserving of more attention. I highlight significant problems associated with a naive view of market efficiency, and advocate a more general model involving noise traders. Finally, I discuss the implications of recent evidence against market efficiency for future capital market research in accounting.

Option Trading and the Intervalling Effect Bias in Beta

Prior studies show that the beta coefficient of a security changes systematically as the length of measurement interval is varied. This phenomenon, which is called the intervalling effect bias in beta, has been attributed to the friction in the trading system that causes the delays in the price-adjustment process. This study shows that option listing is associated with a decline in the beta intervalling effect bias. The decline is most pronounced for small firms. We also find that our sample firms grow significantly after option listing. Since prior research indicates that market value is a major determinant of the magnitude of the intervalling effect, we re-examine our results using a subsample that controls for market value. The results indicate that the decline in the beta bias from the pre-listing to post-listing period is still prevalent after we control for the change in firm size. Overall, the evidence is consistent with the notion that option trading reduces the delays in the price-adjustment process, which in turn reduces the intervalling effect bias in beta.

Asymmetric Effects of Interest Rate Changes on Stock Prices

AbstractThis study examines the stock price adjustment process around announcements of changes in the federal funds rate target in the 1990s using an asymmetric autoregressive exponential GARCH model (ASAR‐EGARCH). We find that target change announcements convey new information to the stock market. Risk aversion increases before the announcement of a rate change, and especially before the announcement of a joint target and discount rate change. The volatility estimates suggest that such joint rate changes send a clearer signal to the stock market about monetary policy objectives relative to unilateral target changes. Our findings are consistent with overreaction in the wake of bad news (rate hikes), and point to a shift in volatility from before to after the rate change announcement since the adoption of the immediate disclosure policy of the Federal Open Market Committee in February 1994.

A discrete and symmetric price adjustment process on the simplex

Abstract We study the tâtonnement process in an exchange economy with three commodities and three agents. We argue that for the multiplicative tâtonnement process the simplex is a natural normalization rule. We analyse the influence of symmetry in preferences and endowments on the dynamics of the tâtonnement process. Depending on this symmetry there are different bifurcation routes to chaos. In particular, coexisting attractors may emerge when the symmetric equilibrium price vector becomes unstable. This coexistence of attractors is robust in the sense that it also exists for close-by asymmetric tâtonnement processes.

Dynamic arbitrage gaps for financial assets: in a nonlinear and chaotic price adjustment process

In this paper we are concerned with the existence of a dynamic arbitrage gap that evolves out of an adjustment process for disequilibrium prices, within a complex dynamics framework which takes into account the market microstructure and transaction costs. Although this gap exhibits nonlinear and chaotic behavior, it does not preclude effective arbitrage transactions from taking place in real markets. This dynamic arbitrage gap depends upon a truly financial gap that accounts for unexpected events and superior information on the professional dealers’ side. In this way, we can learn much more about dynamical adjustment processes from financial assets, making the arbitrage gap instrumental in setting about real arbitrage positions, paving thus an empirical track open to quasi-stochastic simulations which could be run by econometricians in the near future.

An extension of the maximum score estimator for disequilibrium models

Mayer and Dorsey (1998) [Mayer, W.J., Dorsey, R.E., 1998. Maximum score estimation of disequilibrium models and the role of anticipatory price-setting. Journal of Econometrics, 87, 1–4] propose a maximum score estimator for disequilibrium models with anticipatory pricing models. Here I prove consistency under assumptions that allow for more general price adjustment processes. I also show that the smoothing function used in Mayer and Dorsey (1998) can be replaced with a simpler function that requires fewer arbitrary choices by the researcher.

Pricing peculiarities of the UK petrol market

The UK petrol market has experienced, over the last two decades, intense price competition and as such provides a rich source of information on some of the real‐world issues in pricing. Examines the practical mechanisms that have been used in managing price competition and also some of the peculiarities of this market. The petrol retailing market is found to adhere broadly to classical theory of price competition but its special characteristics cause interesting deviations. Of particular note, a “leverage effect” operates whereby price changes affect margins much more than volumes, which leads to behaviour by oil competitors which seems counter‐intuitive. In addition, real‐world issues – such as the price adjustment process and the local nature of competition – present practical difficulties which can have a material impact on the profitability that a textbook exposition of pricing might lead us to expect.