Jean François Houde (University of Wisconsin - Madison), “Price Negotiation in Differentiated Products Markets: The Case of Insured Mortgages in Canada”, Econometrics Seminar, Toulouse : TSE, April 3, 2012, 15:30–17:00, room Amphi S.
This paper measures market power in a decentralized market where contracts are determined through a search and negotiation process. The mortgage industry has many institutional features which suggest it should be competitive: homogeneous contracts, negotiable rates, and, for a given consumer, common lending costs across lenders. As a result, even with a small number of competing lenders, informed borrowers can gather multiple quotes offering interest rates that reflect the expected cost of lending. However, there is important heterogeneity in the ability of consumers to understand the subtleties of financial contracts, in their ability or willingness to negotiate and search for multiple quotes, and also in their degree of loyalty to their main financial institutions. We propose and estimate a model to disentangle the different channels through which market power can arise for a given transaction in this environment. There are two main sources of market power. The first is search frictions. To quantify search frictions the model we develop is sequential; consumers are initially matched with a home bank to obtain a mortgage quote, and can then decide, based on their search costs, whether or not to gather additional quotes from banks in their neighborhood. We find that over the five year period of the contract the average search cost corresponds to an upfront sunk cost of between $1,047 and $1,590. The second main source of market power is switching costs. We estimate that consumers are willing to pay between $759 and $1,617 upfront to avoid having to switch banks.