Optimal timing of defections from price-setting cartels in volatile markets

3 August 2005
Publication Type: Working Paper

We model cartel defection in markets with stochastic demand fluctuations as an investment timing problem. We show that (i) the optimal timing of cartel defection is pro-cyclical, suggesting higher probability of competitive pricing during booms; and (ii) the defection trigger is a positive function of demand variability, and larger than its deterministic demand counterpart, implying that market volatility facilitates collusion. The first result is consistent with the counter-cyclical pricing prediction originally due to Rotemberg and Saloner (1986), but not dependant on lack of persistence in demand fluctuations. The analysis reveals insights on implications of co-variation between volatility and demand shocks.

Series title: Working Paper 003
1 March 2005
Journal: 2006, Economic Modelling, 23(5), 792-804
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