The design of efficient Demand Response (DR) mechanisms for the residential sector entails significant challenges, due to the large number of home users and the negligible impact of each of them on the market. In this paper, we introduce a hierarchical market model for the smart grid where a set of competing aggregators act as intermediaries between the utility operator and the home users. The operator seeks to minimize the smart grid operational cost and offers rewards to aggregators toward this goal. Profit-maximizing aggregators compete to sell DR services to the operator and provide compensation to end-users in order to modify their preferable consumption pattern. Finally, end-users seek to optimize the tradeoff between earnings received from the aggregator and discomfort from having to modify their pattern. Based on this market model, we first address the benchmark scenario from the point of view of a cost-minimizing operator that has full information about user demands. Then, we consider a DR market, where all entities are self-interested and non-cooperative. The proposed market scheme captures the diverse objectives of the involved entities and, compared to flat pricing, guarantees significant benefits for each. Using realistic demand traces, we quantify the arising DR benefits. Interestingly, users that are extremely willing to modify their consumption pattern do not derive maximum benefit. © 1983-2012 IEEE.