Price negotiation in differentiated product markets: An analysis of the market for insured mortgages in Canada

In many differentiated product markets prices are determined through a negotiation process between buyers and sellers. Sellers post a price, but consumers may be able to negotiate a discount. The extent to which sellers negotiate may depend on consumer characteristics; ignoring the actual pricing mechanism can lead to an incomplete and biased analysis. Moreover, discounting is an important form of price discrimination, and therefore an interesting phenomenon worth measuring and understanding. Despite its prevalence, this form of pricing has been largely ignored by researchers studying market power in differentiated products markets. We analyze detailed transaction-level data on a large set of approved mortgages in Canada between 1992 and 2004 and administered by either the Canadian Mortgage and Housing Corporation or Genworth Financial. These data provide information on features of the mortgage, household characteristics (including place of residence), and market-level characteristics. The richness of these consumer data in combination with lender-level location data (MicroMedia ProQuest) allow us to empirically examine the functioning of this important market. We propose a model of bank choice and price negotiation that incorporates three key features of the market: differentiated services, heterogeneous bank valuations of consumers, and search costs. More generally, our goal is to build and estimate a tractable empirical model to analyze differentiated markets in which prices are negotiated rather than posted.