A test for market power exertion in the credit card industry with the dual solow residual

Abstract

This thesis investigates the possibility of market power exertion in the credit card industry, an issue recently raised in the United States Department of Justice's investigation of Visa and MasterCard. Market power is examined using Roeger's (1995) dual residual based on Hall (1988). Roeger's method is extended through the use of directed graphs and especially the exercise of Pearl's (2000) adjustment procedure to determine the appropriate estimation model that corrects for possible stochastic regressor problems. The procedure allows identification of appropriate instruments, which is problematic using Hall's (1988) method. Results from the directed graph analysis offer an appropriate specification to formulate an unbiased OLS regression model. Based on empirical results, the credit card industry does exhibit market power exertion. Findings are consistent with previous studies in the credit card market and other industry studies using the well established Solow residual and dual residual. Furthermore, a new application for directed graphs is introduced. Conclusions support the numerous arguments that a few industry actors control entrance into the credit card market, influence revenues in the industry, and exert market power over credit card consumers and merchants.