Evaluating Cartel Overcharge Models: Model Stability and Reliability of Overcharge Estimates

Reliable estimation of prices in counterfactual worlds that did not (and will never) exist creates many issues, both theoretical and empirical. I focus on forecasting methodologies often employed in estimation of cartel overcharges. I suggest the use of recursive residuals and application of CUSUM and CUSUMSQ tests to assess the reliability of predictions fundamentally driven by implied assumptions of model and parameter stability. The availability of standard, objective tests for model stability based on recursive residuals provide additional support to researchers attempting to reliably estimate cartel overcharges. I apply these techniques to data for a hypothetical cartel, and show the variability of overcharge percentages estimated by various approaches -- comparing simple averages, forecasts and dummy variable approaches.