Dynamic Competition in Negotiated Price Markets
In many credit markets, prices are negotiated repeatedly. The final mortgage rate, for example, is rarely the posted price, but something that borrowers and lenders have bargained over. If borrowers are not satisfied with the rates their lenders propose, they need to search for and negotiate better offers. Borrowers often find it costly and inconvenient to switch lenders. The search and switching costs give incumbent lenders a clear advantage, allowing them to charge relatively high prices.
Repeated interactions between borrowers and lenders create the possibility of dynamic pricing: lenders compete aggressively with low prices to attract new borrowers and then raise their prices once borrowers have made a commitment.
We find such pricing patterns in the Canadian mortgage market, as most borrowers in Canada renegotiate their mortgage every five years. In this paper we develop a framework for studying this type of dynamic competition in similar negotiated-price markets. Our paper suggests that although search costs unambiguously hurt consumers, switching costs are not necessarily harmful. Consumers pay higher rates when they renew, but they reap the benefits of aggressive pricing when the loan begins.