Paper # Author Title
This paper uses the structure of institutional economics to provide an explanation of the recent U.S. financial crisis. Institutional theory suggests that a county’s political, legal, social, and cultural institutions determine and characterize its economy. An institutional perspective of financial crises therefore incorporates unquantifiable aspects of the real world. Different institutions interacted to ignite and fuel the global crisis. A thorough understanding of all of the legal, political, and cultural institution that encompass a society, as well as their role in the market, is needed to explain and avoid the reoccurrences of financial crises. Download Paper
This study investigates the impacts of negative economic shocks on child schooling in households of rural Malawi, one of the poorest countries in Sub-Saharan Africa (SSA). Two waves of household panel data for years 2006 and 2008 from the Malawi Longitudinal Study of Families and Health (MLSFH) are used to examine the impact of negative shocks on child schooling. Both individually-reported and community-level shocks are investigated. A priori the impact of negative shocks on schooling may be negative (if income effects dominate) or positive (if price effects dominate). Also the effects may be larger for measures of idiosyncratic shocks (if there is considerable within-community variation in experiencing shocks) or for aggregate shocks (if community support networks buffer better idiosyncratic than aggregate shocks). Finally there may be gender differences in the relevance for child schooling of shocks reported by men versus those reported by women with, for example, the former having larger effects if resource constraints have strong effects on schooling and if because of gender roles men perceive better than women shocks that affect household resources. The study finds that negative economic shocks have significant negative impacts on child school enrollment and grade attainment, with the estimated effects of the community shocks larger and more pervasive than the estimated effects of idiosyncratic shocks and with the estimated effects of shocks reported by men as large or larger than the estimated effects of shocks reported by women. Download Paper
Despite women’s significant improvement in educational attainment, underrepresentation of women in Science, Technology, Engineering, and Mathematics (STEM) college majors persists in most countries. We address whether one particular institution – single-sex schools – may enhance female – or male – students’ STEM careers. Exploiting the unique setting in Korea where assignment to all-girls, all-boys or coeducational high schools is random, we move beyond associations to assess causal effects of single-sex schools. We use administrative data on national college entrance mathematics examination scores and a longitudinal survey of high school seniors that provide various STEM outcomes (mathematics and science interest and self-efficacy, expectations of a four-year college attendance and a STEM college major during the high school senior year, and actual attendance at a four-year college and choice of a STEM major two years after high school). We find significantly positive effects of all-boys schools consistently across different STEM outcomes, whereas the positive effect of all-girls schools is only found for mathematics scores. Download Paper
I investigate the origins of the now-ubiquitous term ”Big Data," in industry and academics, in computer science and statistics/econometrics. Credit for coining the term must be shared. In particular, John Mashey and others at Silicon Graphics produced highly relevant (unpublished, non-academic) work in the mid-1990s. The first significant academic references (independent of each other and of Silicon Graphics) appear to be Weiss and Indurkhya (1998) in computer science and Diebold (2000) in statistics /econometrics. Douglas Laney of Gartner also produced insightful work (again unpublished and non-academic) slightly later. Big Data the term is now firmly entrenched, Big Data the phenomenon continues unabated, and Big Data the discipline is emerging. Download Paper
We study an individual who faces a dynamic decision problem in which the process of information arrival is unobserved by the analyst, and hence should be identified from observed choice data. An information structure is objectively describable if signals correspond to events of the objective state space. We derive a representation of preferences over menus of acts that captures the behavior of a Bayesian decision maker who expects to receive such signals. The class of information structures that can support such a representation generalizes the notion of a partition of the state space. The representation allows us to compare individuals in terms of the preciseness of their information structures without requiring that they share the same prior beliefs. We apply the model to study an individual who anticipates gradual resolution of uncertainty over time. Both the filtration (the timing of information arrival with the sequence of partitions it induces) and prior beliefs are uniquely identified. Download Paper
The Diebold-Mariano (DM) test was intended for comparing forecasts; it has been, and remains, useful in that regard. The DM test was not intended for comparing models. Unfortunately, however, much of the large subsequent literature uses DM-type tests for comparing models, in (pseudo-) out-of-sample environments. In that case, much simpler yet more compelling full-sample model comparison procedures exist; they have been, and should continue to be, widely used. The hunch that (pseudo-) out-of-sample analysis is somehow the “only," or “best," or even a “good" way to provide insurance against in-sample over fitting in model comparisons proves largely false. On the other hand, (pseudo-) out-of-sample analysis may be useful for learning about comparative historical predictive performance. Download Paper
We study an individual who faces a dynamic decision problem in which the process of information arrival is unobserved by the analyst. We derive two utility representations of preferences over menus of acts that capture the individual’s uncertainty about his future beliefs. The most general representation identifies a unique probability distribution over the set of posteriors that the decision maker might face at the time of choosing from the menu. We use this representation to characterize a notion of “more preference for flexibility” via a subjective analogue of Blackwell’s (1951, 1953) comparisons of experiments. A more specialized representation uniquely identifies information as a partition of the state space. This result allows us to compare individuals who expect to learn differently, even if they do not agree on their prior beliefs. We conclude by extending the basic model to accommodate an individual who expects to learn gradually over time by means of a subjective filtration. Download Paper
This paper studies optimal Ramsey taxation when risk sharing in private insurance markets is imperfect due to limited enforcement. In a limited commitment economy, there are externalities associated with capital and labor because individuals do not take into account that their labor and saving decisions affect aggregate supply, wages and thus the value of autarky. Due to these externalities, the Ramsey government has an additional goal, which is to internalize the externalities of labor and capital to improve risk sharing, in addition to its usual goal - minimizing distortions when financing government expenditures. These two goals drive capital and labor taxes in opposite directions. By balancing these conflicting goals, the steady-state optimal capital income taxes are levied only to remove the negative externality of the capital, and optimal labor income taxes are set to meet the budgetary needs of the government in the long run, despite positive externalities of labor. Download Paper
A large literature uses matching models to analyze markets with two-sided heterogeneity, studying problems such as the matching of students to schools, residents to hospitals, husbands to wives, and workers to firms. The analysis typically assumes that the agents have complete information, and examines core outcomes. We formulate a notion of stable outcomes in matching problems with one-sided asymmetric information. The key conceptual problem is to formulate a notion of a blocking pair that takes account of the inferences that the uninformed agent might make from the hypothesis that the current allocation is stable. We show that the set of stable outcomes is nonempty in incomplete information environments, and is a superset of the set of complete-information stable outcomes. We provide sufficient conditions for incomplete-information stable matchings to be efficient. Download Paper
Savage (1954) provided axioms on preferences over acts that were equivalent to the existence of an expected utility representation. We show that there is a continuum of other expected utility" representations in which for any act, the probability distribution over states depends on the corresponding outcomes. We suggest that optimism and pessimism can be captured by the stake-dependent probabilities in these alternative representations. Extending the DM's preferences to be defined on both subjective acts and objective lotteries, we suggest how one may distinguish optimists from pessimists and separate attitude towards uncertainty from curvature of the utility function over monetary prizes. Download Paper
People often wonder why economists analyze models whose assumptions are known to be false, while economists feel that they learn a great deal from such exercises. We suggest that part of the knowledge generated by academic economists is case-based rather than rule-based. That is, instead of offering general rules or theories that should be contrasted with data, economists often analyze models that are “theoretical cases”, which help understand economic problems by drawing analogies between the model and the problem. According to this view, economic models, empirical data, experimental results and other sources of knowledge are all on equal footing, that is, they all provide cases to which a given problem can be compared. We offer complexity arguments that explain why case-based reasoning may sometimes be the method of choice; why economists prefer simple examples; and why a paradigm may be useful even if it does not produce theories. Download Paper
We propose a model of history-dependent risk attitude, allowing a decision maker’s risk attitude to be affected by his history of disappointments and elations. The decision maker recursively evaluates compound risks, classifying realizations as disappointing or elating using a threshold rule. We establish equivalence between the model and two cognitive biases: risk attitudes are reinforced by experiences (one is more risk averse after disappointment than after elation) and there is a primacy effect (early outcomes have the greatest impact on risk attitude). In dynamic asset pricing, the model yields volatile, path-dependent prices. Download Paper
We develop a model of a Parole Board contemplating whether to grant parole release to a prisoner who has finished serving their minimum sentence. The model implies a simple outcome test for racial prejudice robust to the inframarginality problem. Our test involves running simple regressions of whether a prisoner recidivates on the exposure time to the risk of recidivism and its square, using only the sample of prisoners who are granted parole release strictly between their minimum and maximum sentences and separately by race. If the coefficient estimates on the exposure time term differ by race, then there is evidence of racial prejudice against the racial group with the smaller coefficient estimate. We implement our test for prejudice using data from Pennsylvania from January 1996 to December 31, 2001. Although we find racial differences in time served, we find no evidence for racial prejudice on the part of the Parole Board based on our outcome test. Download Paper
Consider an agent who is unsure of the state of the world and faces computational bounds on mental processing. The agent receives a sequence of signals imperfectly correlated with the true state that he will use to take a single decision. The agent is assumed to have a finite number of "states of mind" that quantify his beliefs about the relative likelihood of the states, and uses the signals he receives to move from one state to another. At a random stopping time, the agent will be called upon to make a decision based solely on his mental state at that time. We show that under quite general conditions it is optimal that the agent ignore signals that are not very informative, that is, signals for which the likelihood of the states is nearly equal. This model provides a possible explanation of systematic inference mistakes people may make. Download Paper
In Medicare Part D, low income individuals receive subsidies to enroll into insurance plans. This paper studies how premiums are distorted by the combined effects of this subsidy and the default assignment of low income enrollees into plans. Removing this distortion could reduce the cost of the program without worsening consumers' welfare. Using data from the the first five years of the program, an econometric model is used to estimate consumers demand for plans and to compute what premiums would be without the subsidy distortion. Preliminary estimates suggest that the reduction in premiums of affected plans would be substantial. Download Paper
Cross-sectional productivity dispersion is countercyclical, at the plant level and at the firm level. I incorporate a firm’s project choice decision into a firm dynamics model with business cycle features to explain this empirical finding both qualitatively and quantitatively. In particular, all projects available have the same expected flow return and differ from one another only in the riskiness level. The endogenous option of exiting the market and limited funding for new investment jointly play an important role in motivating firms’ risk-taking behavior. The model predicts that relatively small firms are more likely to take risk and that the cross-sectional productivity dispersion, measured as the variance/standard deviation of firm-level profitability, is larger in recessions. Download Paper
We consider the impact of job rotation in a directed search model in which firm sizes are endogenously determined and match quality is initially unknown. A large firm benefits from the opportunity of rotating workers so as to partially overcome loss of mismatch. As a result, in the unique symmetric equilibrium, large firms have higher labor productivity and lower separation rates. In contrast to the standard directed search model with multi-vacancy firms, this model can generate a positive correlation between firm size and wage without introducing any ex ante productivity differences or imposing any non-concave production function assumption. Download Paper
We present a dynamic signaling model where wasteful education takes place over several periods of time. Workers pay an education cost per unit of time and cannot commit to a fixed education length. Workers face an exogenous dropout risk before graduation. Since low-productivity workers' cost is high, pooling with early dropouts helps them to avoid a high education cost. In equilibrium, low-productivity workers choose to endogenously drop out over time, so the productivity of workers in college increases along the education process. We find that (1) wasteful education signals exist even when job offers are privately made and the length of the period is small, (2) the maximum education length is decreasing in the prior about a worker being highly productive, and (3) the joint dynamics of returns to education and the dropout rate are characterized, which is consistent with previous empirical evidence. Download Paper
This paper studies the optimal redistribution of income inequality caused by the presence of search and matching frictions in the labor market. We study this problem in the context of a directed search model of the labor market populated by homogenous workers and heterogeneous firms. The optimal redistribution can be attained using a positive unemployment benefit and an increasing and regressive labor income tax. The positive unemployment benefit serves the purpose of lowering the search risk faced by workers. The increasing and regressive labor tax serves the purpose of aligning the cost to the firm of attracting an additional applicant with the value of an application to society. Download Paper
Machina (2009, 2012) lists a number of situations where standard models of ambiguity aversion are unable to capture plausible features of ambiguity attitudes. Most of these problems arise in choice over prospects involving three or more outcomes. We show that the recursive non-expected utility model of Segal (1987) is rich enough to accommodate all these situations. Download Paper
We propose and illustrate a Markov-switching multi-fractal duration (MSMD) model for analysis of inter-trade durations in financial markets. We establish several of its key properties with emphasis on high persistence (indeed long memory). Empirical exploration suggests MSMD's superiority relative to leading competitors. Download Paper
We consider all-pay auctions in the presence of interdependent, affiliated valuations and private budget constraints. For the sealed-bid, all-pay auction we characterize a symmetric equilibrium in continuous strategies for the case of N bidders and we investigate its properties. Budget constraints encourage more aggressive bidding among participants with large endowments and intermediate valuations. We extend our results to the war of attrition where we show that budget constraints lead to a uniform amplification of equilibrium bids among bidders with sufficient endownments. An example shows that with both interdependent valuations and private budget constraints, a revenue ranking between the two mechanisms is generally not possible. Download Paper
We show nonparametric point identification of static binary games with incomplete information, using excluded regressors. An excluded regressor for player ¡ is a state variable that does not affect other players’ utility and is additively separable from other components in ¡’s payoff. When excluded regressors are conditionally independent from private information, the interaction effects between players and the marginal effects of excluded regressors on payoff are identified. In addition, if excluded regressors vary sufficiently relative to the support of private information, then the full payoff functions and the distribution of private information are also nonparametrically identified. We illustrate how excluded regressors satisfying these conditions arise in contexts such as entry games between firms, as variation in observed components of fixed costs. We extend our approach to accommodate the existence of multiple Bayesian Nash equilibria in the data-generating process without assuming equilibrium selection rules. For a semiparametric model with linear payoff, we propose root-N consistent and asymptotically normal estimators for parameters in players’payoffs. Download Paper
We introduce an approach for semiparametric inference in dynamic binary choice models that does not impose distributional assumptions on the state variables unobserved by the econometrician. The proposed framework combines Bayesian inference with partial identification results. The method is applicable to models with finite space for observed states. We demonstrate the method on Rust's model of bus engine replacement. The estimation experiments show that the parametric assumptions about the distribution of the unobserved states can have a considerable effect on the estimates of per-period payoffs. At the same time, the effect of these assumptions on counterfactual conditional choice probabilities can be small for most of the observed states. Download Paper
Bidders’ risk attitudes have important implications for sellers seeking to maximize expected revenues. In ascending auctions, auction theory predicts bid distributions in Bayesian Nash equilibrium does not convey any information about bidders' risk preference. We propose a new approach for inference of bidders’ risk attitudes when they make endogenous participation decisions. Our approach is based on the idea that bidders' risk premium -the difference between ex ante expected profits from entry and the certainty equivalent - required for entry into the auction is strictly positive if and only if bidders are risk averse. We show bidders' expected profits from entry into auctions is nonparametrically recoverable, if a researcher observes the distribution of transaction prices, bidders' entry decisions and some noisy measures of entry costs. We propose a nonparametric test which attains the correct level asymptotically under the null of risk-neutrality, and is consistent under fixed alternatives. We provide Monte Carlo evidence of the finite sample performance of the test. We also establish identification of risk attitudes in more general auction models, where in the entry stage bidders receive signals that are correlated with private values to be drawn in the bidding stage. Download Paper
Most work on social interactions studies a single, composite effect of interactions within a group. Yet in the case of sexual initiation, there are two distinct social mechanisms - peer-group norms and partner availability with separate effects and different potential interventions. Here I develop an equilibrium search and matching model for first sexual partners that specifies distinct roles for these two mechanisms as part of demand and supply. I estimate the model using a national sample of high school students, with data over time on individual virginity status. The results indicate that peer-group norms have a large effect on the timing of sexual initiation for both boys and girls. Changes in opposite-gender search behavior (i.e., partner availability) also have a large impact on initiation rates for boys, but not for girls. The existence of a composite effect of social interactions is also confirmed using a standard method: instrumental variables estimation of linear regressions. Download Paper
This paper posits a notion of the value of an individual’s human capital and the associated return on human capital. These concepts are examined using U.S. data on male earnings and financial asset returns. We decompose the value of human capital into a bond, a stock and a residual value component. We find that (1) the bond component of human capital is larger than the stock component at all ages, (2) the value of human capital is far below the value implied by discounting earnings at the risk-free rate, (3) mean human capital returns exceed stock returns early in life and decline with age and (4) human capital returns and stock returns have a small positive correlation over the working lifetime. Download Paper
I develop and estimate a structural equilibrium model of the college market. Students, having heterogeneous abilities and preferences, make college application decisions, subject to uncertainty and application costs. Colleges, observing only noisy measures of student ability, choose tuition and admissions policies to compete for more able students. Tuition, applications, admissions and enrollment are joint outcomes from a subgame perfect Nash equilibrium. I estimate the structural parameters of the model using data from the National Longitudinal Survey of Youth 1997, via a three-step procedure to deal with potential multiple equilibria. In counterfactual experiments, I use the model .rst to examine the extent to which college enrollment can be increased by expanding the supply of colleges, and then to assess the importance of various measures of student ability. Download Paper
Asymmetric information is an important source of inefficiency when assets (like firms) are transacted. The two main sources of this asymmetry are unobserved idiosyncratic characteristics of the asset (for example, quality) and unobserved idiosyncratic choices (actions done by the current owners). We introduce moral hazard in a dynamic signaling model where heterogeneous sellers exert effort to affect the distribution of a stochastic signal (for example sales or profits) of their firms. Buyers observe the signal history and make price offers to the sellers. High-quality sellers try to separate themselves from the less quality ones in order to receive high price offers, while the latter try to pool with the first group to avoid receiving a low price. We characterize the competitive equilibria of the model, and we propose an adaptation of existing refinements to the incorporation of moral hazard in dynamic signaling that implies uniqueness of equilibria. We find that similar individual characteristics across types of sellers make everyone worse off, since competition increases signaling waste. Also, due to the new intensive margin (effort), non-trivial signaling will take place even when the cost of signaling is large. In particular cases, we find analytical solutions, that allow transparent comparative statics analysis. The model can be applied to education where grades depend not only on the students’ skills, but also on their effort. Download Paper
Consider the following situation involving two agents who belong to a large society. One of the agents needs help to avoid a big loss. The other agent may either incur a low cost to help him or do nothing. If agents do not recognize each other, providing incentives for socially optimal behavior (helping) is, in general, very difficult. We use a repeated anonymous random matching setting in a large society to understand how, in the previous situation, help may take place in equilibrium. We find explicit equilibria that, unlike other models proposed in the literature, feature smooth aggregate behavior over time and robustness to many perturbations, such as the presence of behavioral types or trembles. We consider the joint limit of increasing the size of the society and making it more interactive (or patient.) Under this limit, our equilibria resemble the tit-for-tat strategy for the prisoner’s dilemma, introducing some small probability of forgiveness. The model is also applied to bilateral trade, where the mechanism used to spread deviations is transmissive instead of contagious. The smooth evolution of the aggregate variables over time makes the model suitable for empirical work. Download Paper
What can economists learn from dynamic partial control of chemical reactors? Both chemical reactors and the economy involve many variables that are difficult to fully predict or control. Thus, this paper suggests the use of partial control, which involves indentifying only the key variables that monitor the system. This idea of observing relatively few variables and enabling policy makers to better control the economy is in line with the contributions of Sargent and Sims, who use a limited number of variables to study monetary and fiscal policies. This approach enables a better distinction between cause and effect in the macroeconomy. Download Paper
This paper seeks to draw attention to a flaw in the firm’s Free Cash Flow model and related statement widely accepted in Corporate Finance. We argue that the common offset of any Current Liabilities against Current Assets distorts the FCF size, composition, and volatility, thereby misstating the firm or project size, debt and assets composition, financial leverage, risk profile, and estimated value. We demonstrate empirically that the offset opens opportunities to manipulate the FCF by systematically overstating its size and understating its volatility. We propose to avoid any offset and rename the standardized statement "Valuation Cash Flow" (VCF). Download Paper
We examine markets in which agents make investments and then match into pairs, creating surpluses that depend on their investments and that can be split between the matched agents. In general, each of the matched agents would ”own" part of the surplus in the absence of interagent transfers. Most of the work in the large bargaining-and matching literature ignores this initial ownership of the surplus. We show that when investments are not observable to potential partners, initial ownership affects the efficiency of equilibrium investments and affects the agents' payoffs. In particular, it is possible that reallocating initial ownership could increase welfare on both sides of the match. Download Paper
We study an individual who faces a dynamic decision problem in which the process of information arrival is unobserved by the analyst. We derive a sequence of representations of preferences over menus of acts that capture the individual's uncertainty about his future beliefs. Using the most general representation, we characterize a notion of "more preference for flexibility" via a subjective analogue of Blackwell's (1951, 1953) comparisons of experiments. A more refined representation allows us to compare individuals who expect to learn differently, even if they do not agree on their prior beliefs. The class of information structures that can support such a representation generalizes the notion of a partition of the state space. We apply the model to study an individual who anticipates gradual resolution of uncertainty over time. Both the filtration (the timing of information arrival with the sequence of partitions it induces) and prior beliefs are uniquely identified. Download Paper
Previous research has shown that the reasons for lapsation have important implications regarding the effects of the emerging life settlement market on consumer welfare. We present and empirically implement a dynamic discrete choice model of life insurance decisions to assess the importance of various factors in explaining life insurance lapsations. In order to explain some key features in the data, our model incorporates serially correlated unobservable state variables which we deal with using posterior distributions of the unobservables simulated from Sequential Monte Carlo (SMC) method. We estimate the model using the life insurance holding information from the Health and Retirement Study (HRS) data. Counterfactual simulations using the estimates of our model suggest that a large fraction of life insurance lapsations are driven by i.i.d choice specific shocks, particularly when policyholders are relatively young. But as the remaining policyholders get older, the role of such i.i.d. shocks gets smaller, and more of their lapsations are driven either by income, health or bequest motive shocks. Income and health shocks are relatively more important than bequest motive shocks in explaining lapsations when policyholders are young, but as they age, the bequest motive shocks play a more important role. We also suggest the implications of these findings regarding the effects of the emerging life settlement market on consumer welfare. Download Paper