Exchange rate pass-through and dynamic oligopoly: an empirical investigation

Transcription

1 Journal of Intrnational Economics 5 (000) 89 locat/ conbas Exchang rat pass-through and dynamic oligopoly: an mpirical invstigation a b, * Dominiqu M. Gross, Nicolas Schmitt a Intrnational Montary Fund, Th Institut, 700 9th St. N.W., Washington, D.C. 043, US b Dpartmnt of Economics, Simon Frasr Univrsity, urnaby, Canada V5 S6 Rcivd July 997; rcivd in rvisd form Fbruary 999; accptd 5 May 999 bstract This papr xplicitly tas into account th dynamic oligopolistic rivalry among sourc producrs to valuat th dgr of xchang-rat pass-through. Using rcnt tim-sris tchniqus for th cas of importd automobils in Switzrland, th rsults show that prics ar stratgic complmnts and that th dgr of pass-through is lowr in th long run than in th short run. This is du to th fact that, although som rivals match long-trm pric changs, othrs do not, inducing th producr who facs a chang in xchang rat to absorb a gratr proportion of th variation. Th dgrs of pass-through ar also low with rspct to othr studis which do not ndogniz pricing bhavior. 000 Elsvir Scinc.V. ll rights rsrvd. Kywords: Exchang rat pass-through; Oligopoly; Intrnational trad JEL classification: F; L3; F4; L6. Introduction Th purpos of this papr is to analyz th dynamic proprtis of th xchangrat pass-through in th prsnc of oligopolistic comptition. Th analysis tas advantag of rcnt dvlopmnts in tim-sris conomtrics to fully ndogniz th pricing by producrs from individual sourc countris and thrby invstigat *Corrsponding author. Tl.: ; fax: addrss: schmitt@sfu.ca (N. Schmitt) / 00/ $ s front mattr 000 Elsvir Scinc.V. ll rights rsrvd. PII: S00-996(99)0008-8

2 90 D.M. Gross, N. Schmitt / Journal of Intrnational Economics 5 (000) 89 th ffct of rivalry on th pass-through. To our nowldg, thr is no mpirical study in th pass-through litratur which has analyzd how prics in a mart intract following an xchang-rat shoc. For instanc, in his study of Japans automobil imports to th US, Fnstra (989) uss a compting pric of imports to control for domstic comptition but thr is no fdbac ffct from th chang in forign pric on th domstic pric. Fnstra t al. (996) and Gross and Schmitt (996) construct aggrgat prics for comptitors to control for substitut products. Ths studis us singl-quation stimation mthods and do not xplicitly dvlop th pricing intractions among rivals. Th rlatd litratur on pricing-to-mart is primarily intrstd in invstigating how xport prics can diffr across dstination marts (for instanc, s Gagnon and Knttr (995) and Knttr (993)), not how compting prics in a givn dstination mart ract. Rcognizing lins among individual prics is an important undrtaing sinc th thortical litratur on xchang rat pass-through shows that imprfct comptition may b on of th main causs for th xistnc of incomplt pass-through (Dornbusch, 987; Krugman, 987). This suggsts that whn comptition is oligopolistic, th intrdpndncy btwn prics (both within and across priods) must b tan into account whn assssing th pass-through rlationship. Th aim of this papr is a first attmpt at filling this gap. Th mpirical analysis dals with th Swiss automobil mart whr w trat oligopolistic rivalry among producrs at th country lvl. Th choic of th Swiss mart for th study of xchang rat pass-through and oligopolistic intractions is intrsting for at last two rasons. First, it is on of th fw marts whr thr is no quantitativ rstriction particularly against Japans imports. Th rsults about th bhavior of Japans automobil producrs can thrfor b considrd fr of distortions. s w shall s, Japans producrs play a y rol in th analysis. Scond, it is a mart with no domstic producr and whr no country-spcific group of producrs has a dominant position. Mor than 80% of th Swiss automobil mart is shard by producrs from only four sourc countris. This indicats that oligopolistic comptition and thus, intrdpndnc among prics should b xplicitly tan into account whn invstigating th pass-through rlationship. Du to rcnt dvlopmnts in tim-sris conomtrics, svral of th latst studis of xchang rat pass-through xplicitly rcogniz th fact that xchang rat and pric sris ar oftn non-stationary and may b cointgratd (s Gagnon and Knttr (995) and Goldbrg (995) using vry diffrnt framwors show that th xchang rat pass-through is ndognous to trad rstrictions. t th firm lvl, in 990, mor than 50% of all nw rgistrations of passngr cars in Switzrland hav bn supplid by fiv producrs only, all in our sampl of countris: Opl, VW, Toyota, Ford, Pugot and Rnault (MWM of US, 99, p. 38). This prcntag may undrstimat th concntration ratio within diffrnt catgoris of automobils. For studis of firms bhavior in th automobil industry, s rsnahan (98) and Mrtns and Ginsburgh (985).

3 D.M. Gross, N. Schmitt / Journal of Intrnational Economics 5 (000) 89 9 thuorala and Mnon, 994, 995; Fnstra t al., 996; Gross and Schmitt, 996). To accommodat non-stationarity as wll as th simultanity of pricing, th mpirical invstigation uss an xtnsion of Johansn s (995) procdur dvlopd in Johansn and Juslius (995). It is a two-stp mthod which first tsts for cointgration in a systm of quations and scond, aftr imposing modlrlvant rstrictions, idntifis th short-run structural paramtrs. W find that dynamic pric intrdpndnc xists in this mart both in th short and in th long run. In th short run for instanc, w find that Grman and Japans producrs ract to ach othr s pric changs by about 30% aftr on priod. Th rsults show howvr that th dgr of pass-through is rlativly low compard to othr findings. It is also lowr in th long run than in th short run. W attribut this last rsult to th fact that, although som rival producrs match long-trm pric changs, othrs do not, inducing th producr who facs a chang in xchang rat to absorb a gratr proportion of th variation with tim. Th articl is organizd as follows. In Sction, w motivat th mpirical analysis with a thortical modl of switching costs and oligopolistic rivalry. Th datast is dscribd in Sction 3 and th mpirical implmntation is prsntd in Sction 4. Th rsults ar discussd in Sction 5 and Sction 6 concluds.. Thortical framwor Th goal of th mpirical sction is to invstigat pass-through rlationships in an oligopoly stting. Its aim is not to tst a particular thory but to stimat shortand long-run dgrs of xchang-rat pass-through, whil introducing dynamic adjustmnts in pric stting as wll as pric intr-dpndnc among sllrs. Th purpos of this thortical sction is to provid a modl consistnt with th dynamic st-up undrlying Johansn s procdur. Th implications of th modl ar thn usd to assist in th intrprtation of th rsults. Th chosn thortical framwor is Froot and Klmprr s (989) switching cost modl. With switching costs, consumrs hav ral or prcivd costs of switching to a compting product vn if thr is no significant diffrnc btwn goods (Klmprr, 995). Switching costs sm particularly rlvant to th automobil mart. For instanc, consumrs may b uncrtain about th quality of brands thy hav not drivn. Th us of aftr-sal srvics can ma consumrs fl thy now bttr th producr s local rprsntativ of th automobil thy currntly own than othr rtailrs. Thy may prciv that such a businss rlationship will bring thm a bttr dal in futur transactions than with rprsntativs thy do not now. Consumrs may also dvlop a non-conomic or a psychological brand loyalty which mas switching brand nams difficult. Th y implication is that, whn consumrs fac switching costs, today s mart shars dtrmin tomorrow s profit. In othr words, pric dcisions hav an intrtmporal lin that would not xist without thm. Of cours, thr ar svral

4 9 D.M. Gross, N. Schmitt / Journal of Intrnational Economics 5 (000) 89 3 othr possibl channls gnrating such a lin. Switching costs, by stablishing ths lins purly on dmand considrations, sm spcially rlvant to analys th cas of a small automobil mart without domstic producrs. Considr thn two forign producrs srving a mart with no domstic production. ssum th forign firms xprinc diffrnt variations of th xchang rat with rspct to th currncy of th buyr s mart. To simplify, lt Firm produc in country and Firm, in country, and w st th modl in a two-priod gam (s Klmprr, 995). Th discountd profit of producr ( 5, ) xprssd in its own currncy is V 5 P [ p, p, X ] l P [s ( p, p ), p, p, X ], () t whr is priod t (t 5, ) xchang rat btwn sllr and th buyr s currncy (xprssd in units of th sllr currncy pr unit of th buyr s currncy); P t is firm s profit in priod t in th buyr s currncy; l is th discount factor facd by ; pt is th pric of firm (in th buyr s currncy); s is firm s mart shar in th first priod, and X t is th vctor of xognous variabls dirctly affcting profit in priod t. For our purpos, th main variabls in 4 X t ar s cost of production and s xchang rat. Suppos firms choos prics in vry priod. To find th quilibrium prics, w loo for th closd-loop quilibrium, and thus for th subgam prfct quilibrium of th gam whr playrs can obsrv and rspond to thir rival s pric at vry priod. Th quilibrium prics in th scond priod, conditional on prics ralizd in priod, ar found by maximizing th scond xprssion in () with rspct to pric. If D is th dmand facd by firm in priod and c is s constant marginal cost xprssd in th sllr currncy, Firm (5, ) chooss p maximizing P 5 ( p c / )D (s ( p, p ), p, p ). Th dmand D dpnds on th mart shar s ralizd in th first priod sinc som consumrs who bought thn ar now locd in: prics st in th first priod dtrmin th position of th dmand in th scond priod. Th pric p satisfis th usual first-ordr condition D ( p (c / ))D 95 0, for (5, ), whr D9 is th partial drivativ of D with rspct to p. ssuming that th scond-ordr conditions hold, th Nash quilibrium prics for priod ar ˆp 5 f ( p, p, X, X ), ˆp 5 g ( p, p, X, X ), () 3 For instanc, limitd capacity of production or distribution, adjustmnt costs in production or in prics such as whn contracts xist btwn producrs and rtailrs (mnu costs), or ls sun invstmnts. Limitd capacity of distribution dos not sm to b a major constraint sinc most producing firms ar also wholsalrs on th Swiss mart. 4 Own xchang rat is an lmnt of this vctor sinc costs ar in th sllr currncy whil P t is in th buyr s currncy.

5 D.M. Gross, N. Schmitt / Journal of Intrnational Economics 5 (000) whr X (X ) is Firm s (Firm s) vctor of priod xognous variabls. Of cours, X (5, ) contains c and. firm taing into account switching costs considrs th ffct of its pric in priod on its profit in priod. To find th quilibrium prics in priod, substitut () in () so as to writ () as V 5 P ( p, p, X ) l p ( p, p, X, X ), for (5, ), whr p is a diffrnt function than P sinc it is no longr a function of priod s prics. Th first-ordr conditions ar thn S D P p ]] ]] p p V 5 l 5 0 5,. (3) Sinc p / p, 0 (firms oprat in th lastic portion of thir dmand), P / p. 0, so that prics in priod ar lowr than without switching costs. 5 ssuming th scond-ordr and th stability conditions hold, th prfct Nash quilibrium prics ar found by solving th systm of bst rplis (3). Th solutions dpnd only on th xognous variabls of th modl: ˆp 5 f (X, X, X, X ), ˆp 5 g (X, X, X, X ). For th purpos of this papr, th quilibrium prics () and (4) hav two important implications. First, a variation in on xchang rat in th first priod affcts firms prics ovr both priods. Considr a chang in. Sinc it is an lmnt of X, both pˆ and pˆ ar affctd by a chang in and sinc ths ˆ ˆ prics dtrmin th quilibrium prics in priod (s ()), p and p ar also both affctd by a chang in. Scond, in th long run, thr is a uniqu st of prics and thus, a uniqu st of mart shars. If th long-run quilibrium is such that th xognous variabls ar constant across priods (X 5 X 5 X and X 5 X 5 X ), th long-run quilibrium prics (4) rduc to p 5 f(x, X ) and p 5 g(x, X ), and s ( p, p ) and s 5 s ar uniquly dtrmind. Hnc, following an xchang rat variation, prics ultimatly convrg to th long-run quilibrium consistnt with th xognous variabls. loo at som of th comparativ static proprtis of th modl givs som insight into how prics vary following a chang in (s also Tivig, 996). Considr th ffct of a chang in on first-priod prics, that is th short-run dgr of pass-through. Diffrntiating (3), (4) V dp V dp 5V d, V dp V dp 5V d. Solving (5), (5) In particular, V, 0 whr V 5 V / p, V5V V V V. 0, uv u. uv u,, j 5,, j ±. Whn prics ar stratgic complmnts, w also now that V j j

6 94 D.M. Gross, N. Schmitt / Journal of Intrnational Economics 5 (000) 89 dp V V d dp ]] 5 ](V V V V ); ] 5 ](V V V V ). (6) d Considr th own pric ffct. Sinc P 5 ( p c / )D, thn, using (3), V 5 D ( ), whr 5 ( D / p ) p /D is th lasticity of th first-priod import dmand from (Tivig, 996). Suppos Firm s optimal first-priod pric is not dirctly affctd by a variation of s xchang rat (i.. 6 V 5 0). In this cas, substituting V in (6), V V d dp D dp D ]] 5 ]( )V ; ] 5 ]( )V. (7) d Sinc V, 0 by th scond-ordr conditions, V. 0 (s footnot 5) and V. 0 with stratgic complmntarity, th sign of both xprssions is positiv if is inlastic (prvrs cas) and ngativ othrwis (normal cas). Morovr, uv u. uv u implis udp /d u. udp /d u: th own pric ffct is gratr than th inducd ffct on th rival s pric. In Fig., rprsnts th prvrs cas following an apprciation of s currncy ( falls) whras rprsnts th Fig.. Short-run rivalry. 6 This assumption is consistnt with imprfct capital mobility (s Froot and Klmprr, 989). ltrnativly, th uncovrd intrst parity condition coupld with th hypothsis introducd latr that th xchang rats follow a random wal also lad to V 5 0.

7 D.M. Gross, N. Schmitt / Journal of Intrnational Economics 5 (000) normal cas. Clarly th short-run pass-through can b low vn if prics ar stratgic complmnts. For this, it suffics b clos to on. Th rsults ar quit diffrnt from a static rtrand quilibrium. In a static gam, p is dtrmind by V 5 ( P / p ) 5 0 (from (3) without tim subscript), so that V 5 c / ( D / p ), 0. Using (6), sinc V 5 0, th ffcts of a chang in on prics in a static rtrand gam ar, dp c D dp c D ]] 5]]]] V, 0; ] 5]]]] V, 0. d V p d V p Thr is no prvrs ffct and th chang in pric is simply proportional to th cost ffct of th chang in. Li in (7), udp /d u. udp /d u. Thr is no guarant that th dgr of pass-through from this static gam is highr than th short-run on givn by (7). Still, th lss lastic th import dmand is, th lowr th short-run dgr of pass-through compard to th static cas. Th intuition for ths rsults is clar. With a static rtrand gam, an apprciation of s currncy incrass th cost of production xprssd in th buyr s currncy. s a rsult, p incrass and, sinc prics ar stratgic complmnts, so dos p. With switching costs, th pass-through ffct is richr bcaus Firm tas also into account th ffct of a pric chang on tomorrow s profit. In particular, if th import dmand is inlastic, first-priod changs in profit ar small and chooss to incras its pric with an apprciation of its currncy. It dos so bcaus futur profits ar mor important than th immdiat cost ffct. Whn th dmand is lastic, th ffct of a chang in is normal as th cost ffct dominats th intrtmporal ffct. In addition, switching costs hav a dynamic ffct on prics that a static rtrand gam cannot gnrat. s a rsult, th long-trm dgr of pass-through may diffr from th short-run on. To gt som intuition into th ffcts of a chang in on priod prics, w us (), dp f p f p ]] 5 ]]]] ]]; d p p dp g p g p ] 5 ]]]] ]]. d p p Th pric raction in priod has two ffcts: th stratgic and th own pric ffcts. Suppos th own pric ffcts f / p and g / p ar ngativ (i.. a highr own pric ystrday inducs a lowr own pric today) and f / p and g / p ar positiv (i.. prics ar stratgic complmnts across priods). In this cas, th sign of dp /d and dp /d ar uncrtain. Considr thn two possibilitis. First, suppos p /. 0 so that a chang in has no immdiat ffct on th rival s pric. In this cas, th scond-priod pric ffcts hav opposit signs. Scond, suppos p / ± 0 but f / p and g / p (5, )

8 96 D.M. Gross, N. Schmitt / Journal of Intrnational Economics 5 (000) 89 7 hav th sam (absolut) valu. In this cas, dp /d 5dp /d and priod prics also chang in opposit dirctions. In short, thr ar rasonabl conditions for which th pric ffcts can b xpctd to hav opposit signs in th scond priod. Ths changs ar also smallr than in th first priod sinc both changs ar functions of first priod pric changs. Combind with (7), ths rsults tll us that it is sufficint to hav a normal ffct in priod for th long-run dgr of pass-through to b smallr than th short-run on. With a normal ffct in priod, an apprciation of s currncy lads to a loss of mart shar for Firm sinc dp /d. dp /d. 0. If priod ffcts hav opposit signs thn dp /d. 0 and dp /d, 0 to avoid furthr losss in s mart shar which dcrass th dgr of pass-through. Evn if this two-priod modl capturs wll th intrtmporal ffcts of switching costs on th pricing dcision in any priod, it mass th fact that thr is typically no first priod to th gam. In othr words, in vry priod, firms inhrit consumrs from past priods and must dcid which pric to st, not only to loc in nw consumrs but also to xploit old consumrs who hav bn locd in th past. This balancing act implis that () can b writtn as V t 5 tp t(s ( p t, p t), p t, p t, X t) ltp t(s ( p t, p t ), p t, p t, X t). Firm s bst rply in priod t, taing into account th optimal prics in t, is thn j p 5 R ( p, p, p, X, X ), (8) t t t t t t t for, j 5, ; j ±. Th intrtmporal ffct is now mitigatd by th incntiv 8 to xploit old consumrs. Eq. (8) is th rfrnc quation for th mpirical implmntation of th modl. 3. Th data Th mpirical invstigation concntrats on th pricing bhavior of automobil producrs from svral sourc countris in Switzrland from 977 to 994. On advantag of this mart is that, during th sampl priod, thr was no 7 Tivig (996) shows this is th cas in a Hotlling modl and thus, in a modl whr dmand for a product dpnds on th pric diffrnc btwn imprfct substituts. This is a rasonabl rprsntation of a matur mart li th automobil mart sinc it implis that no firm can incras its mart shar without dcrasing its rival s shar. 8 Klmprr (995) argus that, bcaus of th incntiv to xploit old customrs, th prsnc of switching costs incrass th quilibrium prics with rspct to th quilibrium without switching costs.

9 D.M. Gross, N. Schmitt / Journal of Intrnational Economics 5 (000) quantitativ rstriction and, whn in plac, tariffs wr vry low. In othr studis, quantitativ rstrictions on Japans automobils ithr hav rsultd in th xclusion of this major producr (s Fnstra t al., 996) or hav bn shown to affct th siz of th pass-through paramtr (Gagnon and Knttr, 995; Goldbrg, 995). Th sourc countris undr considration ar lgium (), Franc (F), Grmany 0 (G) and Japan (J). Ths countris captur 85 to 90% of th mart ovr th sampl priod (s Gross and Schmitt (996) for individual mart shars). Othr sourc countris hav bn xcludd from th analysis bcaus thy ar marginal xportrs to th Swiss mart (for xampls, Swdn and th Unitd Stats) or bcaus thy ntrd th mart only rcntly (li Kora and th Czch Rpublic). In both cass, obsrvations ar oftn zro at th quartrly frquncy. On rlativly important xclusion is Italy for which unit-valus ar highly variabl du to th htrognity of th products. F G J Th prics (P, P, P, P ) ar masurd as unit-valus (at th bordr bfor tariffs). Thy ar in currncy of th dstination country (i.. Swiss Francs). Two catgoris ar analyzd sparatly, small-siz and mdium-siz automobils. ordr rcords catgoriz automobils according to th wight. Thus, in th small-siz catgory ar vhicls btwn 800 and 00 g and, in th mdium-siz catgory, vhicls btwn 00 to 600 g. W xcludd th catgory abov 600 g bcaus th charactristics of th products ar lily to hav changd significantly during th priod (for xampl with th dvlopmnt of th mart for four-whl driv rcrational vhicls). Th rmaining variabls ar th cost of production in th sourc countris (C, F G J C, C, C ) which is approximatd by unit labor cost in manufacturing in all countris xcpt lgium for which th producr pric indx in manufacturing is usd. Clarly, th unit labor cost is only a proxy for th marginal cost of production sinc it omits raw matrials for instanc (s Goldbrg and Knttr, 997). W xpct this omission not to crat biasd xchang rat cofficints 9 Morovr, tariffs hav bn shown to hav no significant impact on th pricing stratgy (s Gross and Schmitt, 996). 0 In our trad statistics, th sourc country is th country of production and, in addition to th wll nown brand nams, Grmany is th sourc country for Opl (GM Europ). Ford s production originats ithr from Grmany or from lgium (Commission of th EC, 983, p. 6). Information on th total valus and numbr of units ar from th Statistiqu Mnsull du Commrc Extriur d la Suiss, Dirction Gnral ds Douans, rn. Labor compnsation is th largst componnt of valu-addd in th two-digit lvl industry including automobil production in all countris. In 983, for our countris, it was btwn 6% and 80% of addd-valu and in 99, btwn 56% and 76% (National ccounts Statistics. Main ggrgats and Dtaild Tabls, Unitd Nations, Nw Yor). In Grmany and in Franc, for th automobil industry alon labor compnsation rprsntd 76% on avrag btwn 983 and 989 (Williams t al., 994, Tabl 9.7).

10 98 D.M. Gross, N. Schmitt / Journal of Intrnational Economics 5 (000) 89 sinc th dollar, th main currncy for pricing raw matrials, is not in our spcifications. Th masur w us is partly dtrmind by data availability for long tim-sris and partly by our mpirical approach. Th choic to focus on rivalry and stimat dynamic simultanous bst rply functions has at last two implications: first, w cannot stimat from our datast mor prcis cost masurs 3 as it is don in th PTM litratur. Scond, in th tim-sris contxt th numbr of dgrs of frdom shrins rapidly, w thrfor also assum (and tst) non-ndognity of marginal cost dtrmination with rspct to prics. This amounts to assuming that th marginal cost in producing countris is constant 4 within th rang of variation of thir mart shars in Switzrland. Th nominal F G J xchang rats (E, E, E, E ) ar dfind as sourc-country currncy pr Swiss 5 Franc. Th variabls ar obsrvd at th quartrly frquncy btwn 977 and 994. ll th variabls ar in logarithms and sasonally unadjustd xcpt th unit labor costs. Pr-tsting indicats that all th sris ar non-stationary. Th rsults of ugmntd Dicy Fullr (DF) tsts in Tabl show that for all sris th hypothsis of intgration of ordr cannot b rjctd whil that of intgration of ordr can b rjctd. Hnc, th spcification as wll as th stimating mthodology must ta this fatur into account and both ar dtaild in th nxt sction. 4. Empirical invstigation Th main thortical implications of th modl in Sction ar thrfold: first, xchang rat variations hav intrtmporal ffcts on pric-stting; scond, rivalry may gnrat a lowr xchang rat pass-through in th long-run than in th short-run; third, in th long-run thr is a stabl rlationship btwn rivals prics. Th goal of this mpirical sction is to invstigat th rol of rivalry on th magnitud of th xchang rat pass-through, in th long run and in th short run, in light of ths implications. asd on (8), th modl to b stimatd is a st of bst rply functions for producrs from four sourc countris whr pric lvls ar dtrmind simul- 3 Gagnon and Knttr (995), for xampl, can xploit th tim-sris and cross-sctional dimnsions of thir panl to stimat costs as th common componnt in prics chargd by on sourc country to svral dstination marts for a givn product. 4 In 988, for xampl, total xports of Grman automobils to Switzrland rprsntd.9% of total production. For Franc and Japan thy rprsntd.4% and.%, rspctivly (Hallwag, 990). Goldbrg and Knttr (997) rightly points out that costs might b ndognous to pric in th cas of largr marts. 5 Th costs sris ar from Main Economic Indicators, Organisation for Economic Coopration and Dvlopmnt, Paris. Th xchang rat sris ar from th ulltin Mnsul, Swiss National an, Zurich.

11 D.M. Gross, N. Schmitt / Journal of Intrnational Economics 5 (000) Tabl n Unit-root tsts DF(n): Dxt5 c atim gxt O bdx j tj j5 I[] a I[] DF(6) DF(8) DF(n) a 50 c 5 a 5 0 lgium P (small) () P (mdium) () C () E (4) Franc F P (small) () F P (mdium) () C (0) F E (4) F d b Grmany G P (small) () G P (mdium) () C () G E (4) G cd c Japan J P (small) d () J P (mdium) () J C c.39 c.43.77(4) J E c.89 c (4) a Th null hypothsis in th sris is I[] or I[]. b c±0. c a ±0. d Significant at 0%. Significant at 5%. a tanously. Th prsnc of futur valus rquirs a hypothsis about xpctation formation. It is assumd that costs and xchang rats follow a random wal so that if producrs form rational xpctations, ach pricing quation bcoms solly a function of prsnt and past valus, j j p 5 f [c, c,,, p, p ], (9) t t ti t ti t ti whr, j5, F, G, J, j ± and i 5 ton. Sinc all th sris wr found to b intgratd of ordr, th systm of simultanous pricing consistnt with (9) must b spcifid in first diffrncs. Nvrthlss, if th sris ar cointgratd, a long-run rlationship btwn th lvls can still b idntifid. Th appropriat conomtric mthodology to idntify

12 00 D.M. Gross, N. Schmitt / Journal of Intrnational Economics 5 (000) 89 cointgration in systms is dvlopd in Johansn (995). W us a rcnt xtnsion of that mthodology to stimat th short-run structural paramtrs of th bst rply functions (9) as wll as tst for cointgration (s, Johansn and Juslius, 995). It is a two-stp procdur such that, in th first stp, th prsnc of cointgrating vctors is tstd using a fully unrstrictd modl. This stp tsts for cointgration btwn th four sourc-country pric lvls in ach catgory. It is thrfor consistnt with th xistnc of a stabl long-run rlationship btwn prics (and thus, mart shars) as stablishd in th prvious sction. In th scond stp, structural paramtrs for th pricing quations in first diffrncs ar stimatd using th cointgration rlationship btwn prics as an rror-corrction mchanism. Rstrictions consistnt with (8) ar imposd such that, producrs in ach sourc country ract to rivals prics but not to rivals costs and xchang rats. 4.. First-stp: cointgration analysis Th Johansn mthodology rquirs th spcification of a VR modl. s th numbr of dgrs of frdom shrins rapidly, our stratgy is to dsign th most parsimonious spcification consistnt with normality of rsiduals sinc th rsults ar valid only for wll-bhavd rrors. Th starting numbr of lags is st qual to for lvl variabls. vctor of constants is introducd and tstd for significanc. Th spcification for ach automobil catgory includs four fully ndognous F G J F G J prics (P, P, P, P ), four waly xognous cost variabls (C, C, C, C ) F G J and four waly xognous xchang rat variabls (E, E, E, E ). W xpct costs not to b ndognous to th prics of automobils (s footnot 4). lso, th unit labor cost is unlily to b snsitiv to xchang rat variations. Th rstriction of wa xognity for costs and xchang rats is imposd at th outst and formally tstd aftr th dtrmination of th cointgrating 6 rlationships. Th stability of th paramtrs is tstd ovr th last 4 obsrvations of th sampl ( ). In this first stp of th analysis, th idntification of cointgration btwn prics is basd on an unrstrictd modl, i.. all th variabls ntr all pric quations and thr is no rstriction on th paramtr valus. For th small-siz catgory normality of th rsiduals is achivd with a 7 constant, thr sasonals and two lags. Th priod, howvr, is shortnd to 977. until 99.3 sinc valus of prdictiv Chow-tsts ovr th last 4 6 W follow Johansn (99a,b) who show that th full modl can b dividd into a conditional modl and a marginal modl whr wa xognity bcoms a linar rstriction on th marginal modl. Th tst is thn an F-tst such that th cofficints on th cointgrating vctor idntifid by th rducd-ran analysis is zro. 7 S Gross and Schmitt (999) for dtaild rsults of th normality and cointgration tsts.

13 D.M. Gross, N. Schmitt / Journal of Intrnational Economics 5 (000) 89 0 obsrvations indicat a clar bra in svral quartrs aftr Paramtr constancy btwn 99.4 and is rjctd such that F(5, 9)55.5 (P-valu50.000). Th bra may b associatd with th introduction in 99 of th singl Europan mart. lthough Switzrland is not a mmbr of th Europan Union, th pricing in th Swiss mart may still hav bn affctd whn producrs adjustd thir stratgis for th Europan mart. In th mdiumsiz catgory of automobils, normality of th rsiduals is achivd with two lags and no constant. Th hypothsis of no constant could not b rjctd by th L.R. tst at 5% lvl significanc (x [3] 5 4.0). In that catgory, forcasts ovr th last 4 obsrvations could not idntify a major bra in pricing. Th rsults of th tsts for cointgration show that for th small-siz automobils, th hypothsis of on cointgrating vctor cannot b rjctd and th valid vctor is G J F P P 0.633P.47P 5 0. (0) Th cas of th mdium-siz catgory is lss clar-cut but th hypothsis of no 8 cointgration can b rjctd at 0% significanc and th cointgrating vctor is, G J F P P P P 5 0. () Onc th cointgrating vctors ar idntifid, th hypothsis of wa xognity of costs and xchangs rats is formally tstd. Th F-valus ar 0.54 (P-valu5 0.8) for th small-siz catgory and.8 (P-valu50.7) for th mdium-siz catgory so that th wa xognity of costs and xchang rats cannot b rjctd. For ach catgory of automobils, th cointgrating vctors (0) and () idntify a stabl rlationship btwn pric lvls by producrs from th four sourc countris. Thir xistnc is consistnt with th rsults of th thortical sction. In ffct, w hav stablishd that, in a gam among intrdpndnt producrs, th long-run quilibrium prics (and thus mart shars) ar uniqu. This implis th xistnc, but not th uniqunss, of a rlationship btwn ths prics. Th fact that thr is at last on cointgrating vctor dfining a stabl rlationship btwn long-trm prics indicats that sllrs may indd aim at long-run mart shars. 4.. Scond-stp: stimation of th short-run paramtrs Th scond stp is th stimation of th structural paramtrs for th pricstting quations in diffrncs. It rquirs taing into account th rstrictions 8 Cointgration tsts, li unit-root tsts, hav low powr in small sampls and 0% significanc lvl is rcommndd (s Dicy and Rossana, 994, Sction III). lso, following Grangr (997), w invstigatd cointgration in pairs of prics. In both catgoris, th hypothsis of no-cointgration is rjctd for all pairs of prics (s Gross and Schmitt, 999).

14 0 D.M. Gross, N. Schmitt / Journal of Intrnational Economics 5 (000) 89 imposd by th thortical framwor. In particular, ach sourc country prics automobils according to its own cost, own xchang rat and comptitors prics. Th constraints that th cofficints on othr countris cost and xchang rats ar zro ar thus xplicitly introducd. Thr ar two xcptions which rlat to th fact that most of th automobils xportd from lgium ar producd by Grman ownd plants. W lt th Grman cost and xchang rat variabls ntr unrstrictdly th pricing quation from lgium and th lgian cost and 9 xchang rat variabls ntr unrstrictdly th Grman pricing quation. lso, in this scond stp, following Johansn and Juslius (995), w fix th cofficints of th cointgrating vctors (0) and () and trat thm as rror-corrction 0 trms. Th final spcifications ar obtaind by following th gnral to spcific procdur and th systm is stimatd by thr-stag-last-squars. Th rsults ar givn in Tabl for small-siz automobils, and in Tabl 3 for mdium-siz automobils. for analyzing th rsults, a fw commnts about thir robustnss ar in ordr. First, in both catgoris th rsiduals ar normally distributd and srial corrlation is absnt. Scond, in spit of th numrous rstrictions dictatd by th thortical modl, our final systm dos not appar to b misspcifid (th valus for th L.R. tst for ovridntifying rstrictions ar rasonably clos to th critical valus). Third, th cofficints on th cm trms ar rmarably clos to thos found in th unrstrictd stimations. Thir slightly smallr siz can b attributd to th introduction of an additional lag for th dpndnt variabl in som quations to corrct for srial corrlation. Th similarity of valus indicats that th rstrictions of zro-ffct from othr countris costs and xchang rats ar wll supportd by th data. Hnc, sourc-country producrs follow a stratgy whr in addition to comptitors prics, thy car only about thir own costs and thir own xchang rat. Not that th convrgnc toward quilibrium prics is xpctd to b much slowr in th mdium-siz than in th small-siz sinc th cm cofficints ar smallr. Finally, th significant constants in th small-siz catgory indicat quality changs may hav occurrd during th priod. 5. Rsults W divid th discussion of th rsults in thr parts. First, w loo at th short-run impact of changs in xchang rat on producrs own prics. Scond, 9 Th rlvanc of th Grman lgium cross-ffct (as opposd to othr country combinations) is supportd by vidnc on th ratio of th valu of forign vs. domstic parts in ach automobil. For xampls, in 979, th ratio of Grman parts in a Frnch automobil was only 9.3% but it was 06% in a lgian automobil. Th ratio of Frnch parts in a Grman automobil was 6.% (own calculations from Commission of th EC, 983, p. 0 ff.). 0 Th othr cointgrating vctors ar constraind to hav zro cofficints. This dos not appar to b in violation to th unrstrictd spcification sinc thir rspctiv wights in th first-stp ar all vry small.

15 D.M. Gross, N. Schmitt / Journal of Intrnational Economics 5 (000) Tabl Pricing quations: small-siz automobils, DP t a,b lgium (5) Franc (5F) Grmany (5G) Japan (5J) Constant 0.5 (0.8) 0.30 (.3) (.4) 0.9 (.) DC ti i (.) DEti i5 i50 i (.6) 0.8 (.4) 0.83 (4.4) DPti i5 i50 i (3.5) 0.49 (.) 0.8 (3.9) F DP ti G DPti i5 i5 i5, i (.) 0.05 (.4) 0.7 (.) 0.4 (.7) 0.78 (.7) J DP ti i5 i5 i (.5) 0.86 (.0) (3.8) cmt 0.4 (0.9) 0.3 (.6) 0.30 (.5) 0.08 (.3) G DCti i5 n.a. n.a. n.a. 0.5 (.6) DC ti n.a. n.a. i5 n.a (.6) n Corr. actual and prdictd Norm. rsid c x () 4-lag srial corr d x (6) L.R. tst for ovrindntifying rstrictions x (67)59.99 a bsolut t-valu in parnthss. b Th critical valus at 5% (0%) ar 5.99 (9.0) for dgrs of frdom and 6.96 (3.999) for 6 dgrs of frdom, rspctivly. c x 5 [(T m)/6]3 [SK (/4)EK ] whr m is th numbr of rgrssors, SK is swnss and EK is xcss urtosis. d x 5 Tor for j 5,,..., 6. j w loo at pric rivalry among sourc countris. Third, w invstigat th dynamics of prmannt and tmporary xchang rat variations. W pay particular attntion to th long-run dgr of xchang rat pass-through and th dynamics of th pric rivalry btwn sourc countris. Whn possibl, w compar our rsults with thos of othr studis. 5.. Exchang rat pass-through W start with th short-run xchang rat pass-through prsntd in Tabls and 3. For both catgoris of automobils, th cofficints for changs in xchang rat ar ngativ in th Grman and Japans quations. Thus, starting from an

16 04 D.M. Gross, N. Schmitt / Journal of Intrnational Economics 5 (000) 89 Tabl 3 Pricing quations: mdium-siz automobils: DP t lgium (5) Franc (5F) Grmany (5G) Japan (5J) DCti i50 i5 i5 i (.0).399 (3.7) 0.35 (.3) 0.60 (.4) DE ti i5 i50 i (.) 0.54 (.6) 0.0 (.) DPti i5 0.4 (3.8) F DP ti i5 i5 0.4 (4.) 0.74 (.6) G DP ti i5, (3.3) 0.3 (3.0) J DP ti i5, i5 0.6 (.9) 0.96 (.7) 0.75 (.8) cmt (0.9) 0.9 (4.) (.8) (.9) G DC ti (5G) i50 n.a. n.a (.) n Corr. actual and prdictd Norm. rsid x () Sr. corr. x (6) L.R. tst for ovrindntifying rstrictions x (67) Tsts of paramtr constancy ovr rstrictd spcification: Cumulativ tst: x (48)/ Forcast F-form: F(48, 5) (P-valu50.63). a bsolut t-valu in parnthss. a quilibrium, an apprciation of th Grman Mar (DM) or of th Japans Yn lads to an incras in th corrsponding pric of th sourc country. Not howvr, that th spd of rspons varis. Th rspons is immdiat for Grman producrs in both catgoris and for Japans producrs in th mdium-siz catgory. It is dlayd by on priod in th Japans small-siz catgory. In most instancs th ffct is small and somtims it is wa (Japan, small-siz catgory). t bst, th short-run ffct of an xchang rat shoc is 50% and most cofficints ar around 5%. Grman producrs hav a noticably diffrnt rat of pass-through across catgoris. Whil it is only 3% in th small-siz catgory, it is 5% in th mdium-siz catgory. Gagnon and Knttr (995) idntify a similar bhavior on th US mart whr th pass-through for larg Mrcds is almost full and around 0% for smallr MW. Ths rsults rflct th normal cas whn th xchang rat changs. ccording to Sction, th diffrncs in pric

17 D.M. Gross, N. Schmitt / Journal of Intrnational Economics 5 (000) rsponss indicat that th natur of th import dmand may b diffrnt for th small-siz catgory and for th mdium-siz catgory. In th pricing of small automobils from lgium, th xchang rat variabl rflcts th prvrs ffct arising from a low lasticity of import dmand. Howvr, it can also rsult from th particular natur of lgian production (s footnot 0). In ffct, an apprciation of th xchang rat btwn th Swiss and th lgian Franc (DE,0), ctris paribus, ncssarily implis that Grman producrs ar facing an apprciation of th lgian Franc (F) vis-a-vis ` th G G Grman currncy (i.. E 5(F/ DM)3E with E constant). Thus, costs G originating in Grmany (C which appars significantly in th quations for lgium) ar falling whn masurd in lgian Francs and, as a consqunc, producrs in lgium drop th pric of automobils xportd to Switzrland. W tstd this hypothsis by stimating th final complt pricing modl with th Grman cost variabl transformd in local currncy in th lgian quation. Th G xchang rat E loss all significanc and th cofficint on C hardly changs with incrasd significanc supporting th rol of Grman costs in lgian Francs. Whil th positiv xchang rat sign can b rlatd to Grman ownd production in lgium, th sam sign in th Frnch mdium-siz quation can only b attributd to th prvrs ffct arising from inlastic dmand for imports. Finally, unli othr studis of pass-through, w did not impos constraints on th cost lasticitis. Thr is no clar vidnc that th data would support th rstriction of symmtric pass-through of xchang rat and costs as thr is a significant diffrnc btwn thir rspctiv cofficints. This suggsts that prics may not b st in th buyr s currncy (s Gross and Schmitt (996) and Gagnon and Knttr (995) for furthr vidnc). 5.. Pric rivalry Considr now th short-trm pric rivalry among producrs. striing fatur of th rsults is that pricing-rivalry is sourc-country spcific and product-catgory spcific. Thr ar two clar cass of pair wis rivalry. In th small-siz catgory, Grman and Japans producrs ract to ach othr s pric changs. Morovr, thr is a rmarabl symmtry in th siz (around 5%) of th on-priod lag rspons. In th mdium-siz catgory th dual rivalry is btwn Frnch and Japans producrs. In this cas almost 30% of th pric chang is tan into account by ach rival although Frnch producrs nd two quartrs to adjust fully. In both instancs, th cofficints ar positiv so that ach producr has an incntiv to follow its rival s pric chang. In trms of Sction, prics ar j stratgic complmnts (i.. V / p p. 0, 5, ; j ± in (3)). S Gross and Schmitt (999) for mor dtails.

18 06 D.M. Gross, N. Schmitt / Journal of Intrnational Economics 5 (000) 89 Intrstingly, ths rsults of pair wis rivalry btwn sourc countris ar consistnt with th vidnc on substitution at th product lvl found by rry t al. (995) (-L-P, hraftr). In thir study of th US automobil mart, thy find that Mazda 33 and Nissan Sntra ar clos substituts for Ford Escort and Chvy Cavalir (Opl Kadtt for GM Grmany). Our findings that Japans and Grman producrs compt dirctly on th small-siz mart ar consistnt with this product substitution sinc, in our sampl, all th Nissan, Mazda, Ford modls and 95% of th Opl modls ar in th small catgory. Morovr, in 988, ths modls had vry similar listd pric rangs (i.. btwn SFr5,000 and SFr3,000 dpnding on th options). Hnc, th modls found to b substituts in -L-P compt in th sam mart nich in our sampl. In th mdium-siz catgory, th lin btwn th -L-P rsults and our sampl is lss dirct bcaus our rsults show pair wis rivalry btwn Frnch and Japans and -L-P do not hav Frnch automobils in thir sampl. Howvr, thy find that in th largr catgory, Honda ccord and Ford Taurus (Ford Sirra in Grmany) ar clos substituts. In 988, th listd prics of ths modls wr in th sam bracts as thos of two rlativly popular Frnch modls, Pugot 505 and Rnault 5. gain, it appars that th modls idntifid as lily substituts in -L-P and xportd to Switzrland, compt not only in th sam catgory but also in th sam pric rang. Not that in all cass but two, automobils from diffrnt sourc-countris ar stratgic complmnts. lso, producrs from lgium do not sm to car about pricing rivalry. Thir only raction is in th small-siz catgory and to Grman pricing. This is of cours consistnt with th fact that most of th lgian production is by Grman ownd firms. This conclusion is rinforcd by th strong cost complmntarity btwn lgian and Grman production (i.. cost variations in Grmany ar passd onto lgian prics). Thr is no lin, howvr, btwn Grman and lgian prics in th mdium-siz catgory. Th diffrnc in th unit-valus of automobils producd in th two countris is also much largr in 3 that catgory. s it will bcom clar in th simulation rsults, th absnc of rivals prics in th lgian quations is consistnt with stratgic pricing by Grmany. Finally, in all cass xcpt lgium th cofficint for th rror-corrction mchanism is significant. Th spd of adjustmnt, howvr, is much largr in th small-siz catgory than in th mdium-siz catgory. Not that givn th way th cointgrating vctor is spcifid, w xpct a ngativ sign for Grmany and a positiv sign in all othr cass. Pric and wight for ach modl ar givn in Hallwag (988). 3 Th avrag unit-valus, in Swiss Francs, ovr th sampl ar th following: for small-siz F G J automobils P 5,996, P 5,54, P 54,8, P 50,76 and for mdium-siz automobils, F G J P 59,308, P 58,968, P 56,97, P 55,85.

19 D.M. Gross, N. Schmitt / Journal of Intrnational Economics 5 (000) Pric dynamics To gain a bttr undrstanding of th dynamics of pricing as wll as to assss th dgr of pass-through in th long-run, w hav run simulations for xchang rat variations in th two currncis for which th pass-through ffct mattrs th most, th Japans Yn and th Grman Mar. Two typs of shocs ar considrd, a prmannt and a tmporary apprciation, both x-post obsrvations sinc w assum xchang rats follow a random wal. Fig. tracs th priod-by-priod cumulativ impact of a 0% prmannt 4 chang in currncy for th prics of small-siz automobil. Not that priod prics chang in opposit dirctions. Whil th producr dirctly affctd by th Fig.. Cumulativ ffct of 0% prmannt apprciation on th pric of small automobils. 4 S Gross and Schmitt (999) for th graphic illustration of all cass.

20 08 D.M. Gross, N. Schmitt / Journal of Intrnational Economics 5 (000) 89 currncy apprciation dcrass its pric, th rival producr incrass it. Hnc, thr is a systmatic attmpt by th producr dirctly affctd by th apprciation to rgain th mart shar lost with th initial shoc. s a rsult, th long-trm dgr of xchang rat pass-through (that is, th pric ffct onc all th adjustmnts hav tan plac) is lowr than th short-trm dgr of pass-through. Th cas of a prmannt xchang rat shoc is intrsting bcaus th impact on rlativ prics is rathr diffrnt across currncis and across catgoris. Th prcntag changs in quilibrium prics ar givn in Tabl 4. prmannt apprciation in th Mar provos an incras in most prics. In particular, Grman producrs manag to induc thir Frnch rivals to almost match thir incras in th small catgory (0.55% vs. 0.75%) and to mor than match it in th mdium catgory (4.98% vs. 4.05%). In both catgoris, automobils pricd in lgium ract vry littl thrby suggsting that Grman producrs us thir offshor production to control thir rivals, in particular Japans producrs who do not ract as much as th Frnch. s indicatd arlir, this bhavior is consistnt with th fact that lgian-producd automobils ar in mor dirct comptition with rivals than with Grman-producd automobils. n apprciation of th Yn hardly lads to any raction by comptitors of Japans products, immdiatly or in th long-run. Thus, Japans producrs ar forcd to dcras thir pric from th initial impact causing rivals to follow suit. s a rsult, Japans producrs hav difficultis inducing thir rivals to match thir incras in prics in ithr catgory. In fact in all but on cas, comptitors lowr thir prics. Th xcption is Frnch producrs in th small catgory, who incras thir pric by 0.30% whil th xchang rat shoc raiss th Japans pric by.63%. Considr now th impact of a tmporary shoc namly, a singl priod chang followd by a rvrsal of th chang in th nxt priod. Fig. 3 illustrats th priod-by-priod dynamics of th pric changs of th four sourc countris following a tmporary apprciation of th Japans Yn in th small-siz catgory. Th scond-priod rvrsal of th first-priod xchang rat apprciation lads to a pric ovrshooting such that th country dirctly affctd by th apprciation corrcts its pric in ordr to rgain mart shars lost in th first priod. Th rmaining oscillatory movmnts ar drivn by th ngativ autocorrlation in th Tabl 4 Prcntag changs in quilibrium prics following 0% apprciation in xchang rats Grman Mar apprciation Japans Yn apprciation Small Mdium Small Mdium lgium 0.% 0.99% 0.7% 0.38% Franc 0.55% 4.98% 0.30%.5% Grmany 0.75% 4.05% 0.5% 0.39% Japan 0.3% 3.40%.63% 0.54%

21 D.M. Gross, N. Schmitt / Journal of Intrnational Economics 5 (000) Fig. 3. Priod to priod ffct of a 0% tmporary apprciation of th Japans Yn on th pric of small automobils. first diffrnc in prics. Not that tmporary shocs hav only tmporary ffcts on prics and thrfor th man of th sris is zro. To masur th rlativ variability of th sris following a shoc, w hav computd th ratio of th varianc of ach rival s pric sris against th varianc of th prics of th producr dirctly affctd by th shoc. Th maximum rlativ variability in th small-siz catgory is against lgium for th Mar apprciation [Var()/ Var(G)50.074] and against Grmany for th Yn apprciation [Var(G)/ Var(J)50.3]. In th mdium-siz catgory, th maximum rlativ variation is 0.0 for Mar apprciation and 0.05 for Yn apprciation against Franc in both cass. Thus, comptition is strongr in th small-siz catgory than in th mdium-siz on and, variations in th Yn lad to mor turbulnc in prics than variations in th Mar. Nvrthlss, th ovrall variability rmains small for tmporary shocs. This can b attributd to two factors: th small dgr of pric intrdpndnc in th short run and th low adjustmnt cofficint of th cm trm. Still th pair wis comptition btwn Japans and Frnch producrs in th mdium-siz catgory and spcially th pair wis comptition btwn Japans and Grman producrs in th small-siz catgory ar quit important. Finally, th diffrnc btwn th short-run and th long-run dgr of pass-through is striing. Som hav suggstd this is consistnt, among othr things, with invoicing in th buyr s currncy (Gagnon and Knttr, 995). W find th rsult is also consistnt with rivalry btwn producrs which can gnrat th following gnral pattrn. Suppos an apprciation of its currncy incrass Firm s pric in priod. Whthr or not th rival producr racts immdiatly to this pric chang, Firm s pric incrass mor than Firm s. s a rsult, Firm

22 0 D.M. Gross, N. Schmitt / Journal of Intrnational Economics 5 (000) 89 loss mart shar. In priod, Firm racts by dcrasing its pric whil Firm gos in th opposit dirction and incrass its pric. Firm can afford to incras its pric bcaus it has gaind mart shar in th first priod. Firms thn continu to ract to ach othr s pric until convrgnc to th initial (for tmporary shoc) or to th nw (for prmannt shoc) long-run quilibrium. Th dynamic adjustmnts just dscribd abov also rsult in a gnrally lowr long-run dgr of pass-through than what is found in analyss without ndognous rivalry. Our findings can b compard to two othr studis which stimat long-run pass-through without simultanous pricing: Gagnon and Knttr (995) which studis pricing by Japans and Grman producrs in a varity of dstination marts and Gross and Schmitt (996) which studis th pricing on th Swiss mart with a datast similar to ours. Gagnon and Knttr find that th long-run dgr of pass-through by Japans producrs is zro for small automobils on th Swiss mart and around 0% for largr automobils across most othr dstination marts. Grman producrs xhibit 50% pass-through across various dstinations. Gross and Schmitt find a zro pass-through for Grman automobils whil it is 37% and 67% for small- and mdium-siz Japans automobils. Th long-run dgrs of pass-through obtaind in this study ar qual or lowr than thos found in ths two paprs. 6. Conclusion In this papr w hav invstigatd th rol of rivalry on pricing in gnral and on th xchang rat pass-through in particular. W chos th Swiss mart for automobils as th import mart bcaus thr is no dominant producr and it is consistnt with an oligopoly stting with four sourc-countris covring a larg fraction of th mart. nothr important fatur of this mart is th absnc of significant distortionary trad barrirs against Japans automobils. Th main mssag of this papr is that pric intrdpndnc mattrs and that xchang rat variations can hav significant fdbac ffcts on rivals prics lading to smallr pass-through in th long-run than in th short-run. Using rcntly dvlopd conomtric tchniqus for systm stimations whn sris ar intgratd, w hav shown that rivals ta this intr-dpndnc into account in two ways. First, w hav uncovrd a stabl long-run rlationship among prics which is consistnt with long-run quilibrium oligopolistic prics. Scond, in th short-run, w hav found that rivalry is sourc-country spcific and catgoryspcific. In particular, two clar cass of pair-wis rivalry hav bn found: Japan and Grmany in th small-siz automobil mart, and Japan and Franc in th mdium-siz automobil mart. oth giv ris to significant changs in prics whthr th shoc is tmporary or prmannt. For instanc, w found that som rivals match prmannt pric changs. s for th dgr of xchang rat pass-through, w discovrd that, in th short

23 D.M. Gross, N. Schmitt / Journal of Intrnational Economics 5 (000) 89 run, it is rlativly small sinc it is always lss than 50%. With prmannt changs in xchang rats, th producr dirctly affctd by xchang rat variations absorbs an incrasing proportion of th xchang rat chang through tim bcaus th main rivals maintain or vn dcras thir pric. s a consqunc, th long-run dgr of pass-through is vry low. Ths rsults ar rmarabl givn th fact that th pric sris ar unit-valus for country-spcific sourcs and not product-spcific prics. This study shows that th tim-sris approach to pricing can b a usful tool to invstigat pric intrdpndnc in gnral. Th analysis of xchang rat changs offrs th advantag of frqunt and rlativly larg variations compard to othr pric componnts. Hnc, our approach may contribut to a bttr undrstanding of th rol of rivalry in particular and mart structurs in gnral. cnowldgmnts W than thr rfrs and Robrt Fnstra for hlpful commnts as wll as Simon ndrson, ill Francis, and sminar participants at th Univrsity of Nottingham. Th usual disclaimr applis. This papr was writtn whn D.M. Gross was a mmbr of RIIM and th Dpartmnt of Economics at Simon Frasr Univrsity and whn th authors wr visiting th Univrsity of Virginia, EPRU at th Copnhagn usinss School and th Univrsity of Gnva. Ths institutions ar thand for thir hospitality. N. Schmitt acnowldgs financial support from th Social and Humanitis Rsarch Council of Canada. Th viws xprssd ar thos of th authors and do not ncssarily rprsnt thos of th Fund. Rfrncs thuorala, P., Mnon, J., 995. Exchang rats and stratgic pricing: th cas of Swdish machinry xports. Oxford ulltin of Economics and Statistics 57, thuorala, P., Mnon, J., 994. Pricing to mart bhaviour and xchang rat pass-through in Japans xports. Th Economic Journal 04, 7 8. rry, S., Lvinsohn, J., Pas,., 995. utomobil prics in mart quilibrium. Economtrica 63, rsnahan, T.F., 98. Dparturs from marginal cost pricing in th mrican automobil industry. Journal of Economtrics 7, 0 7. Commission of th EC, 983. Concntration, Comptition and Comptitivnss in th utomobil Industris and in th utomotiv Componnt Industris of th Europan Community, Documnt by C. Marfls, Luxmbourg. Dicy, D.., Rossana, R.J., 994. Cointgratd tim sris: a guid to stimation and hypothsis tsting. Oxford ulltin of Economics and Statistics 56, Dornbusch, R., 987. Exchang rats and prics. mrican Economic Rviw 77, Fnstra, R.C., 989. Symmtric pass-through of tariffs and xchang rats undr imprfct comptition: an mpirical tst. Journal of Intrnational Economics 7, 5 45.