The effect of large price changes on market competition within duopolies with an application towards the COVID-19 financial crisis

Abstract

Does a strong stock price performance for one firm in an industry suggest industry wide market positivity or could it be that good news for one firm is bad for the rest in light of competition? Does your opinion change if the firm’s price falls sharply? It is likely you can imagine scenarios where both sides of the argument could be correct. There are undoubtable situations where good news for one firm is good for all. Think of the emerging autonomous vehicle industry: if one firm releases significant testing results that suggest autonomy leads to fewer automobile crashes, it is likely that everyone in the market will reap the benefit of consumer trust. Will all firms reap benefit of equal magnitude? Likely not; but overall, it is good news for the entire industry. This general behavior does not, however, hold up in all or even most cases. This can be seen clearly with tech companies. When Apple produces a revolutionary product like the iPhone, the economic significance will be felt very differently across the mobile phone industry. Great news for Apple, in this case, is terrible news for Microsoft and its sales of mobile phones. The same train of thought applies to negative events, and you can undoubtably imagine scenarios where both sides could be true. This paper generalizes market competition by tracking duopoly performance following large price movements in order to better understand general return correlations amongst competitors. Extensive research has been done into the predictability of returns following large price shocks; however, this research focuses primarily on the firm whose price is moving. This paper focuses on examining the effect of a large price movement on the competitor’s prices, in particular how duopolies react to such events. In line with methodology of previous research, initial analysis begins with sample characteristics and returns before filters are applied to the sample in hopes of obtaining more significant and consistent returns across events. The initial sample consists of events over a two-year period for five prominent duopolies. The primary focus of this research is on established duopolies; that is, duopolies whose market split has been affectively established over years of competition, but minor applications are also applied to one recently developed public duopoly, Uber and Lyft. After first filtering out events associated with a public announcement and then observing which of these events create a significant volume change, post event returns over a 20-day period are then calculated. Initial results suggest significant economic results for the competition; however, following an out of sample test over a different two-year period, results lack consistency in the magnitude of economic significance. Overall, after considering all available data from both the primary analysis and out of sample test, results of this suggest that a strong positive price movement for one firm in a duopoly is in fact good news for the partner within the duopoly as well. Negative events, however, have the opposite effect in that the competition experiences positive price movement following the event suggesting that on average bad news for one firm, is good news for its competition. This paper was compiled primarily during the economic recession as a result of the prominent COVID-19 virus. In light of the recent, extreme market conditions, further research and considerations have been applied to understand duopoly price movements in light of economic disaster. In particular, how the model used in this report must adapt when observing a crisis and how the firms within the studied duopolies perform versus each other and more generally, against the S&P 500 index.