Friday, October 4, 2013

The price of diamonds

The diamond market is really strange. The wholesale market is dominated by a single firm that basically acts like a monopolist, as it is able to control supplies with large stockpiles (and even get a bailout from the government) and thus sets the prices at will. The resale market is heavily self-regulated to limit the supply from others than the dominant firm (just try to resell your diamond and get more than half what you paid for it...). Thus, if you would want to study price setting in this market, you would want to look at it from the angle of a monopolist trying to maximizing its profit and extracting as much as possible from demand.

Nicolas Vaillant and François-Charles Wolff do none of it. They just apply a hedonic regression and blindly regress selling prices on diamond characteristics. It is interesting that they find that there are some important non-linearities at round carat sizes, but is to be expected given the marketing by the diamond industry. But what quickly put me off in this paper is that the authors do not seem to understand some basics of economics. Here is a quote from the first paragraph:
In 2003, world demand for rough diamonds (US$9.5 billion) was significantly above the diamond supply (US$8.2 billion), so that the excess demand had to be satisfied from producers’ existing stockpiles.
First, by definition, supply includes stockpiles. How one would measure supply by ignoring the stock is a mystery to me. And how could one quantify supply and demand separately like this? In addition, it is not like there is rationing going on, which would justify higher demand than supply, as I cannot imagine that a monopolistic supplier set prices below equilibrium. After this opening paragraph, I cannot trust anything in the paper.

PS: And I just realized this is the second time I criticize a paper by these two authors...


Anonymous said...


Anonymous said...

such description of the diamond market is found on other webpages:
supply refers to current supply for the year 2003 (rough diamonds
extracted), which does not include stockpiles.
it sounds curious to criticize the paper on the basis of one
sentence which has nothing to do with the content of the paper:
definitely not a scientific and trusty behavior !

Kansan said...

It seems very unscientific to put an unrelated and confusing sentence at the start of a paper.

Anonymous said...

Boy are those authors naive. And they find it is OK to quote because it is on some website, without thinking just a little? And they we should trust the rest of the paper? Good point EL.