Advantages And Disadvantages Of The Lerner Index
There are also some measures of bank competition like Lerner index. Lerner index was developed in 1934 by the American economist, Abba Lerner. The Lerner index is defined as the difference between price and marginal cost, divided by price. The value of Lerner index ranges from a minimum of zero to a maximum of one. When P=MC, the Lerner index is zero, which indicates that the firm has no pricing power. As the value of Lerner index increases, the difference between price and marginal cost becomes bigger which indicates that banks have higher market power (Ariss, 2010). In other words, LI=0 indicates that there is perfect competition, while LI=1 means the market is in a condition of Monopoly. Casu and Girardone (2009) argue that Lerner index of Monopoly power measures the degree of market power very well and it is a good and widely used indicator in measuring competition in banking literature. …show more content…
2009). There are also some arguments relating to the disadvantages of the Lerner index. Fernandez de Guevara et al. (2005) argue that there are several problems with regards to the estimation of the Lerner index. First, the value of the Lerner index changes according to different revenues used by study. Second, the cost of risk, which is very important in the profit and loss account of banking system, is not considered in general practice. The ignorance of the cost of risk can be attributed to reasons such as data insufficient and calculation difficulties. If the cost of risk in not included in the estimation of cost function, it will lead to wrong interpretation of the Lerner index due to the fact that the margin is
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