Pricing in Segmented Markets, Arbitrage Barriers and the Law of One Price: Evidence from the European Car Market

Abstract:

The paper examines automobile price differences in the Single Market for the 1993-98 period. The absolute law of one price is strongly rejected, but there is some convergence to its relative version. Two sets of explanations are considered: (i) price-setting in segmented markets and (ii) arbitrage barriers. The role of price-setting variables is seriously overestimated when arbitrage factors are not controlled for. Evidence for Belgium and Luxembourg suggests that the single currency will lower price differences significantly. Arbitrage trade is also likely to become more effective if the block exemption is not extended beyond 2002.

Keywords: Law of One Price, Market Segmentation, Arbitrage, Gravity Model.

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