TESTING INTERNATIONAL PRICE TRANSMISSION UNDER ...

Price Transmission and the Law of One Price
Exchange rates “pass-through” on output prices, which has been studied in
relation to pricing to market behaviour, and exchange rate risks do have an effect
on export prices (Miljkovic 1999, p.134-135).
Finally, imperfect flows of information can rise the cost of arbitraging.
Moreover, price transmission might also be characterized by asymmetry, i.e. it
differs according to whether prices are increasing or decreasing (in magnitude,
speed or both). Price transmission asymmetry implies a different distribution of
welfare than what we would have under symmetry and might be a manifestation
of market failure (for a survey see Meyer and von Craumon-Taubadel 2004).
Asymmetric adjustment costs, asymmetric information and, of course, market
power might be at the origin of horizontal price transmission asymmetry (see
paragraph 3.3.2.2 14 ).
At this point, it should be clear that distance and transportation costs, after
adjusting for exchange rates, don’t account for international price variability.
Miljkovic (1999, p.130) notes that this is implicitly recognized in Stigler and
Sherwin (1985) already: when claiming that a product’s prices “tend” to move
together, they are aware of the existence of multiple prices for a good in the same
market. “Because it is recognized that international markets are (generally) far
from perfect, it is not clear why imposing the LOP in international agricultural
trade modelling is so critical” (Miljkovic 1999, p.130). Moreover, a number of
the studies aiming at testing the LOP have national or at most interregional
dimension (Baulch 1997; Sexton et al. 1991).
In most empirical models (see chapter 3), all sources of deviations from the
LOP not explicitly considered amongst the regressors turn out to be included in
the error term. This, in turn, implies strong assumptions on their behaviour. For
example, we can anticipate that, in cointegration models, which will be
extensively dealt with in the remainder of this work, they are assumed to be
stationary (if the model is expressed in logarithms, stationary around a constant
proportion of prices).
An important consequence is that, being the hypothesis at the basis of the LOP
very strict, a transmission parameter will summarize the overall effect of a set of
factors affecting price signals (transaction costs, the existence of market power
and so on). The fact that some of this elements change proportionally with the
prices while some others directly impact on price spreads, and that their effects
are likely to interact with each other, further complicate the analysis.
Nevertheless, still the value of the parameters and their significance level provides
information about the extent to which markets share the same price shocks
(Conforti 2004, p.5). At the same time, knowledge of the institutions and
14 In agricultural economics, asymmetric price transmission is an issue extensively dealt with in vertical price
transmission analyses (see for example Meyer and von Craumon-Taubadel 2004).
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