Handbook of Competition in Banking and Finance
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Handbook of Competition in Banking and Finance

Edited by Jacob A. Bikker and Laura Spierdijk

For academics, regulators and policymaker alike, it is crucial to measure financial sector competition by means of reliable, well-established methods. However, this is easier said than done. The goal of this Handbook is to provide a collection of state-of-the-art chapters to address this issue. The book consists of four parts, the first of which discusses the characteristics of various measures of financial sector competition. The second part includes several empirical studies on the level of, and trends in, competition across countries. The third part deals with the spillovers of market power to other sectors and the economy as a whole. Finally, the fourth part considers competition in banking submarkets and subsectors.
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Chapter 5: Competition, concentration and critical mass: why the Herfindahl–Hirschman Index is a biased competition measure

Jaap W.B. Bos, Yee Ling Chan, James W. Kolari and Jiang Yuan


Empirical literature and related legal practice using concentration as a proxy for competition measurement are prone to a fallacy of division, as concentration measures are appropriate for perfect competition and perfect collusion but not intermediate levels of competition. Extending the classic Cournot model used to derive the Hirschman–Herfindahl Index (HHI) of market concentration, we propose an adaptation of this model intended to remove the aggregation bias and omitted variable bias that exist in many empirical studies. Application of our model and new critical mass measures to data for US commercial banks in the period 1984–2013 confirms that concentration measures are indeed unreliable competition metrics. Our results lead us to conclude that critical mass builds upon HHI as a market power metric that incorporates competitive information not contained in HHI. Policy and future research implications are briefly discussed.

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