Testing Firm Conduct

Abstract

Evaluating policy in imperfectly competitive markets requires understanding firm behavior. While researchers test conduct via model selection and assessment, we present advantages of Rivers and Vuong (2002) (RV) model selection under misspecification. However, degeneracy of RV invalidates inference. With a novel definition of weak instruments for testing, we connect degeneracy to instrument strength, derive weak instrument properties of RV, and provide a diagnostic for weak instruments by extending the framework of Stock and Yogo (2005) to model selection. We test vertical conduct (Villas-Boas, 2007) using common instrument sets. Some are weak, providing no power. Strong instruments support manufacturers setting retail prices.