ABSTRACT
An ideal test for Contestable Markets Theory (CMT) is to determine the rate of implicit and explicit interest paid on deposits by banks or the interest charged on loans over the entire test period. A direct measurement for CMT that has been used by Morrison and Winston is the compensating deviation measurement. Fundamental finance provides this measure to examine CMT. Theoretically, the net incremental after tax cash flows associated with entry into and exit from the various product markets for the new competitors as well as the changes for the incumbents could be calculated and then subjected to net present value analysis. A one factor model is used to examine the effects of pre- and post-product entry on commercial bank’s stock returns. A banking organization exists almost entirely of such nonproductive assets. This fact will bias the test to finding the expected result for contestability that there is no advantage to being an industry insider.
