DP2187 Why Does the 'Law of One Price' Fail? A Case Study

Author(s): Jonathan Haskel, Holger C Wolf
Publication Date: July 1999
Keyword(s): Arbitrage, Exchange Rate Passthrough, Imperfect Competition, Law of one price, Mean Reversion, Price Setting
JEL(s): D40, E30, F41, L81
Programme Areas: Industrial Organization, International Trade and Regional Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=2187

We use retail transaction prices for a multinational retailer to examine the extent and permanence of violations of the law of one price (LOOP) for identical products sold in a variety of countries. We find median deviations of twenty to fifty percent. The differences are not systematic across very similar goods within a product group (e.g. two types of mirrors), nor across product groups, ruling out differences in local distribution costs as an explanation of violations of the LOOP, and pointing instead to differences in mark-ups. While divergences are large at a point in time, both their extent and their duration is limited, suggesting the presence of significant indirect competitive pressures.