Fraud, investments and liability regimes in payment platforms

•We model the impact of fraud losses on the prices charged by a payment platform.•We assume that merchants can invest in fraud detection technologies.•The platform lowers the merchant price if consumers are not liable.•If consumers are not liable, the platform's allocation of losses maximizes welfare.•Our results are modified if we assume that merchants are risk averse.

In this paper, we discuss how fraud losses impact the price structure chosen by a monopolistic payment platform, if merchants can invest in fraud detection technologies. We show that liability rules bias the structure of the prices charged by the platform to consumers and merchants with respect to a case in which such a responsibility regime is not implemented. If consumers are liable for fraud, the profit-maximizing price structure is neither biased in favor of consumers nor merchants. If consumers are not liable for fraud, the platform lowers the price for merchants to provide them with investment incentives. Under the zero liability rule for consumers, the profit-maximizing allocation of fraud losses maximizes social welfare.