"The Bigger They Are, The Harder They Fall": How Price Differences Across U.S. Cities Are Arbitraged

Paul G. J. O'Connell, Shang-Jin Wei

NBER Working Paper No. 6089
Issued in July 1997
NBER Program(s):   IFM   ITI

Recent empirical work has made headway in exploring the non-linear dynamics of deviations from the law of one price and" purchasing power parity that are apt to arise from transaction costs. However, there are two important facets of this work that need improvement. First, the choice of empirical specification is arbitrary. Second, the data used are typically composite price indices which are subject to potentially serious aggregation biases. This paper examines the evidence for transport-cost-induced nonlinear price behavior within the U.S. We address both of the above shortcomings. First, we use a simple continuous-time model to inform the choice of empirical specification. The model indicates that the behavior of deviations from price parity depends on the relative importance of fixed and variable transport costs. Second, we employ data on disaggregated commodity prices, yielding a pure' measure of the deviations from price parity. We find strong evidence of nonlinear reversion in these deviations. The nature of this reversion suggests that fixed costs of transportation are integral to an understanding of law-of-one-price deviations.

download in pdf format
   (470 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w6089

Published: O'Connell, Paul G. J. and Shang-Jin Wei. "'The Bigger They Are, The Harder They Fall': Retail Price Differences Across U.S. Cities," Journal of International Economics, 2002, v56(1,Jan), 21-53.

Users who downloaded this paper also downloaded* these:
Obstfeld and Taylor w6053 Nonlinear Aspects of Goods-Market Arbitrage and Adjustment: Heckscher's Commodity Points Revisited
Goldberg and Verboven w8402 Market Integration and Convergence to the Law of One Price: Evidence from the European Car Market
Taylor w7577 Potential Pitfalls for the Purchasing-Power-Parity Puzzle? Sampling and Specification Biases in Mean-Reversion Tests of the Law of One Price
parsley and Wei w5654 Convergence to the Law of One Price Without Trade Barriers or Currency Fluctuations
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us