From our model, a firm with a lower price support will
tend to have a greater depth of discount. Under P1, for
example, Firm 2 has a greater probability of discounting at
a lower price than Firm 1, as evidenced in the CDF plot of
Figure 1, Panel B. Across all possible conditions of the
model’s propositions, we expect to observe that, on average,
retailers with higher SLRs will have greater discount depth
(H1e) and a greater maximum discount depth (H1f).
Although summary statistics of retailers’ prices can
indicate whether the SLR explains price promotions, a more
rigorous test would consider the entire price dispersion
curve. Theoretically, we have clear predictions about how
equilibrium price distributions should appear (Figures 1 and
2). We test whether the empirical price distributions vary as
predicted by analyzing stochastic dominance. For any two
CDFs, Fj(x) first-order stochastically dominates Fi(x) iff
Fj(x) ≤ Fi(x), ∀x. In other words, if Firm j’s price CDF lies
nowhere above and somewhere below Firm i’s distribution,
Firm j first-order dominates. In Figure 1, Panel B, for example,
Firm 1 first-order stochastically dominates Firms 2 and
3, and Firm 2 dominates Firm 3. First-order dominance is a
fairly strict standard when considering empirical price distributions
that may include shocks or random error. Secondorder
stochastic dominance is similar except that it considers
the deficit functions, or the integral of the CDF.
Second-order stochastic dominance holds under first-order
dominance, but not vice versa. Our model predicts that, on
average, a firm with a lower SLR will stochastically dominate
a firm with a higher SLR.
H2: The price distributions of retailers with a lower SLR firstand
second-order stochastically dominate firms with a
higher SLR.
H2 addresses the relationship between SLR and price distributions
among all retailers, and H3 more narrowly focuses
on retailers with the smallest loyal segment size (Firm 3).
Small retailers with a high SLR should discount heavily
(P1), whereas small firms with a low SLR should price high
(P2). Therefore, we can distinguish the pricing strategies of
small retailers according to their SLR values.
H3: The price distributions of small retailers with a high SLR
are first- and second-order stochastic ally dominated by
small firms with a lower SLR.