An Instrumental Variables Approach to Testing Firm Conduct under a Bertrand-Nash Framework

Understanding firm conduct is crucial for industrial organization and antitrust policy. In this article, we develop a testing procedure based on the Rivers and Vuong non-nested model selection framework. Unlike existing methods that require estimating the demand and supply system, our approach compares the model fit of two first-stage price regressions. Through an extensive Monte Carlo study, we demonstrate that our test performs comparably to, or outperforms, existing methods in detecting collusion across various collusive scenarios. The results are robust to model misspecification, alternative functional forms for instruments, and data limitations. By simplifying the diagnosis of firm behavior, our method offers researchers and regulators an efficient tool for assessing industry conduct under a Bertrand oligopoly framework. Additionally, our approach offers a practical guideline for enhancing the strength of BLP-style instruments in demand estimation: once collusion is detected, researchers are advised to incorporate the product characteristics of colluding partners into own-firm instruments while excluding them from other-firm instruments.