Oligopolistic Interdependence and the Structure of Production in Banking: An Empirical Evaluation

The main purpose of this paper is to incorporate the oligopolistic nature of the banking industry into the (conventional) production model in order to contribute to the empirical literature on the structure, conduct and performance in banking and to achieve unbiased measures of scale economies and efficiency depending on which of the models is accepted by the data. This is done by appending behavioral equations specifying banks' conjectures regarding the reactions of other banks to its output change. This formulation enables us to test for the correct type of behavioral model and relate it to the resulting estimated technology. If estimates of economies of scale and inefficiencies depend on the behavioral model adopted, other studies which ignore product market behavior may well be subject to misspecification errors. The paper also sheds light on the nature of the oligopolistic interdependence in the banking sector. Copyright 1994 by Ohio State University Press.