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We develop a theory of the firm in which the willingness of workers to cooperate with each other plays a central role. We study a dynamic principal-agent problem. In each period, the firm (the principal) chooses an incentive intensity (how much to pay workers per-unit of measured output) and the employees (the agents) allocate effort between individual production and tasks that involve cooperating with other employees. Following the literature on organizational behavior, (i) employees are willing to engage in cooperative tasks even when these tasks are less effective at increasing their measured output and (ii) the level of cooperation is increasing in past levels of cooperation in the firm and decreasing in the incentive intensity. Hence, an increase in the incentive intensity does not just increase current effort, it has important dynamic consequences: future employee cooperativeness falls. We show how the firm balances these two effects to maximize its lifetime profits. By extending the set of employee motivators beyond the purely financial, we are able to introduce a precise definition of corporate culture and to show how firms optimally manage their culture. Our theory helps explain why different firms, placed in similar “physical” circumstances, choose different incentive systems. It also helps explain how corporate culture can be a hard-to-imitate asset which yields some firms excess profits. Download Paper
This paper examines the strategy of investing in seven Latin American emerging stock markets: Mexico, Brazil, Argentina, Colombia, Peru, Venezuela, and Chile. International Portfolio investment gradually increased during the late 1980s and the 1990s in this region. Investors willing to assume the additional risk present in these markets have been well compensated. Yet, many market analysts have indicated that such markest are somewhat of an abnormality, in that they tend to be characterized as thin, narrow and driven by poorly informed individuals rather than by fundamentals. The optimization algorithms include Markowitz variance-covariance and lower partial moment. The optimal portfolios are evaluated using criteria such as terminal wealth, Sharpe utility measure, Treynor and Jensen measures, and reward to semi-variance. In addition, portfolios which employed ̄rst, second and third degree stochastic dominances are presented. It is shown that possesing a diversified international portfolio which includes Latin American stocks is beneficial. Download Paper
Understanding the spatial search of burglars is based upon rational choice models which were developed in environmental criminology and economics, and applied also in regional science. The objective is to see whether the behavior of burglars is rational and whether they evaluate alternative courses of action, including the location of the home, its attributes and surroundings, and the security precautions held in the target choice. Such understanding is significant in the design of strategies for police and private security companies aimed at reducing residents' risk of becoming burglary victims. Such findings can also aid residents in selecting the most effective physical security precautions and the preferred behavior to minimize the probability of being victimized. Furthermore, local governments may choose to reduce their visibility and leave space for market forces to fulfill some of the functions and duties that are currently considered to be police responsibility. This paper offers an empirical model which explains the target choice by residential burglars. The model can also be used to predict the relative effectiveness of various security measures in reducing burglary incidents. A logistic regression analysis was employed to estimate the probability of households being burgled as a function of the location of the home with respect to major arterial routes, as well as the attributes of the house, immediate surroundings, and the security precautions that were in use. Download Paper
This paper analyses the optimal investment strategy in the stock markest of a selected group of South American countries: Mexico, Brazil, Argentina, and Chile. The Markowitz efficiency frontiers are derived based on daily stock market index returns expressed in US dollars, for the period of January 1, 1988 through December 23, 1993. In addition to the Markowitz algorithm, the low partial moment algorithm is used. The benefits of international diversification are studied from the perspectives of an American investor who can invest both in the U.S. and in the South American stock markets. The paper assesses the risks and rewards of investing in these countries based on both foreign exchange as well as sovereign risks. It is shown that the optimal portfolio derived provides a risk-adjusted return that is better or, as good as, the return realizable from investing in stock markets with lesser degrees of risk. The optimal portfolio is calculated based on stock-market returns for the emerging South American countries mentioned, with the S&P 500 Index incorporated into the analysis. The portfolio's performance is then measured using various portfolio evaluation techniques. Download Paper
We use an OLG model to examine democratic choice between two modes of government support for education: subsidies for privately purchased education and free uniform public provision. We find little conflict between democracy and growth: the same factors that generate popular support for subsidization over free uniform provision large external benefits, a large excess burden and little inequality - also favor its relative growth performance. Furthermore, restricting the franchise to an upper-income elite may also reduce growth. Two extensions examine the effect of intergenerational mobility and indicate the theoretical possibility of periodic swings in the balance between public and private spending. Download Paper
This paper examines the behavior of European Community stock markets in light of decreased barriers to internatinal investments and improved accessibility to information. The Vector Autoregression (VAR) model is able to identify the main channels of interactions and simulate the responses of a given market to innovations in other markets. The daily returns are expressed in terms of German Marks, reflecting the outlook of European investors. This paper hypothesizes that an innovation in one market is directly, rather than serially, transmitted to all other markets. The research shows that no market is found to be completely isolated from ther others; however, these patterns of transmittal are still consistent with international market efficiency. Download Paper
This paper examines the effects of various economic factors on the black market exchange rate premium in developing countries using monthly data from 1985 to 1989. The model analyzes the interaction of stock and flow conditions in determining both the premium on the black dollar and the stock of black money. Some of the factors this paper hypothesizes to de­ termine the black market premium is the official real exchange rate, the official depreciation-adjusted interest rate differential, the level of exports, and a seasonal factor associated with tourism. The empirical results tend to agree with the findings of Dornbusch et. a1. (QJE, February 1983). These results are important because they provide a starting point for governments to control the level of black market activity. Download Paper
Incomplete information, local interaction and random matching games all share a common mathematical structure. A type or player interacts with various subsets of the set of all types/players. A type/player's total payoff is additive in the payoffs from these various interactions. This paper describes a general class of interaction games and shows how each of these three classes of games can be understood as special cases. Techniques and results from the incomplete information literature are translated into this more general framework. A companion paper, Morris [1997], uses these techniques to derive new results concerning contagion in local interaction games. Download Paper
Each player in an infinite population interacts strategically with an infinite subset of that population. Suppose each player's binary choice in each period is a best response to the population choices of the previous period. When can behaviour that is initially played by only a finite set of players spread to the whole population? This paper characterizes when such contagion is possible for arbitrary local interaction systems (represented by general undirected graphs). Maximal contagion occurs when local interaction is sufficiently uniform and there is low neighbour growth, i.e., the number of players who can be reached in k steps does not grow exponentially in k. Download Paper
The standard model of repeated games assumes perfect synchronization in the timing of decisions between the players. In many natural settings, however, choices are made asynchronously so that only one player can move at any given time. This paper studies a family of repeated settings in which choices are asynchronous. Initially, we examine, as a canonical model, a simple two person alternating move game of pure coordination. There, it is shown that for sufficiently patient players, there is a unique perfect equilibrium payoff which Pareto dominates all other payoffs. The result generalizes to any finite number of players and any game in a class of asynchonrously repeated games which includes both stochastic and deterministic repetition. The results complement a recent Folk Theorem by Dutta (1995) for stochastic games which can be applied to asynchronously repeated games if a full dimensionality condition holds. A critical feature of the model is the inertia in decisions. We show how the inertia in asynchronous decisions determines the set of equilibrium payoffs. Download Paper
This paper illustrates an alternative approach to modelling frictions. Frictions are not assumed to exist, but are shown to arise endogenously as a distinctive feature of the set of equilibria that correspond to a particular range of parameter values. To avoid building frictions in the environment, the information imperfections typically assumed in search-theoretic models are eliminated. In addition, the model’s spacial structure and the agents’ moving decisions are explicitly spelled out, allowing the number of contacts that occur to depend on the way agents choose to locate themselves. It is shown that some heterogeneity among locations is necessary although not sufficient for the equilibria of the model to exhibit frictions. An aggregate matching function is shown to exist, and its behavior with respect to changes in parameters such as the distances between locations, the agents’ payoffs and the sizes of the populations of searchers on each side of the market is completely characterized. Finally, the model is used to quantify the e¤ect of a recent change in taxicab fares on the process that rules the meetings between passengers and taxicabs in New York City. Download Paper
This paper analyzes statistical discrimination in a model with endogenous human capital formation and a frictionless labor market. It is shown that in the presence of two distinguishable but ex-ante identical groups of workers discrimination is sustainable as an equilibrium outcome. This is true irrespective of whether there are multiple equilibria when the groups have no distinguishable characteristics. When an affirmative action policy consisting of an employment quota is introduced in the model it is shown that affirmative action can "fail" in the sense that there may still be equilibria where the groups are treated differently. However, the incentives to invest for agents in the disadvantaged group are better in any equilibrium under affirmative action than in the most discriminatory equilibrium without the policy. Thus, the lower bound on the fraction of agents from the disadvantaged group who invest in their human capital is raised by the policy. The welfare effects are ambiguous. It is demonstrated that the policy may increase the incentives to invest and reduce the expected payoffs for all agents in the target group simultaneously. Indeed, the policy may hurt the intended beneficiaries even when the initial equilibrium is the worst equilibrium for the targeted group. Download Paper
Suppose we replace "knowledge" by "belief with probability p" in standard definitions of common knowledge. Very different notions arise depending the exact definition of common knowledge used in the substitution. This paper demonstrates those differences and identifies which notion is relevant in each of three contexts: equilibrium analysis in incomplete information games, best response dynamics in incomplete information games, and agreeing to disagree/no trade results. Download Paper
Many financially distressed firms remain highly levered, invest little, and perform poorly after emerging from a debt restructuring. As a consequence, they often reenter distress shortly after the restructuring. This paper presents a theory of dynamic liquidation that is consistent with these findings. Postponing the liquidation decision allows creditors to learn about the firm’s prospects and implement a better liquidation policy. However, there is a trade-off between optimal liquidation and optimal investment because creditors learn more about the firm’s prospects if the firm forgoes some profitable long-term projects. When creditors resolve this trade-off in favor of learning, the firm suffers from the consequences of distress even after emerging from the restructuring. The theory has implications for the costs of financial distress and bankruptcy law. Download Paper
We analyze a model in which there is socially inefficient competition among people. In this model, self-enforcing social norms can potentially control the inefficient competition. However, the inefficient behavior often cannot be suppressed in equilibrium among those with the lowest income due to the ineffectiveness of sanctions against those in the society with the least to lose. We demonstrate that in such cases, it may be possible for society to be divided into distinct classes, with inefficient behavior suppressed in the upper classes but not in the lower. Download Paper
Vector Auto Regression (VAR) models are used to trace the dynamic linkages across daily returns of national stock market indices of Latin America, and among the Latin American and major world stock market indicies. The Latin American indices include: Argentina, Brazil, Chile, and Mexico. The majorworld stock market indices include: the US; the world excluding the US; United Kingdom; Japan; Germany; France; and Canada. Although most of the impulse responses die out very quickly, it is still possible to trace the dynamic linkages among markets. The dynamic linkages among the Latin American markets and among the Latin American and major world stock markets are found to be relatively small. The conclusion is that although markets are efficient and cleared out in a few trading days, there are dynamic linkages that can be explored and exploited to the benefit of the diversified international investor. Download Paper
We study community enforcement in a private information, random match- ing setting, where buyers privately "network" for information and sellers have a short term incentive to supply low quality. We also show that high quality can be sold in a sequential equilibrium with population M even when each buyer periodically interacts with only N*(M) players where 0 < lim M->infinite (N^*2)/M < infinite: We show that when networking is costly and M is large, low quality is supplied with positive probability in any Nash equilibrium. For this case, we characterize conditions for a sequential equilibrium in which both high and low quality are supplied. Download Paper
In the present paper a pure exchange, general equilibrium model is considered and the equilibrium set is studied. It is shown for all total endowments and an open and dense set of preferences that if there are l >= 2 commodities and m >= 2 consumers then there exists a set of distributions of endowments with nonempty interior such that the associated economies have at least l - 1 + min{l,m} equilibria for l + min{l,m} even and at least l - 2 + min{l,m} equilibria for l + min{l,m} odd. Download Paper
In a model of exchange with price-taking individuals, the existence of non-trivial underemployment equilibria with walrasian prices is proved for a generic set of economies. The likelihood of the occurrence of these equilibria is higher the farther the economy is from a Pareto optimal initial allocation, and the larger the economy is, when considering log-linear preferences. Moreover, these equilibria can be interpreted as the result of some self-fulfilling beliefs. We show how markets are vulnerable to psychological effects translating aggregate signals into bad expectations, which are nonetheless rational in the sense of being confirmed in equilibrium. The possibility of distortions in market allocations is essentially derived from: 1) myopic individual behavior preventing sufficient ex- perimentation; 2) the timing of "production" decisions; 3) the absence of certain financial contracts; 4) the fear of government restrictions on supply. Download Paper
Policy persistence refers to the tendency of the political process to maintain policies once they have been introduced. This paper develops a theory of policy persistence based on the idea that policies create incentives for beneficiaries to take actions which increase their willingness to pay for these policies in the future. The theory is used to show that policy persistence may lead to "political failure", in the sense that policy sequences arising in political equilibrium can be Pareto dominated. In addition, the theory is used to provide an explanation as to why \policy conditionality" may have permanent effects. Download Paper
A number of papers have shown that a strict Nash equilibrium action profile of a game may never be played if there is a small amount of incomplete information (see, for example, Carlsson and van Damme (1993a)). We present a general approach to analyzing the robustness of equilibria to a small amount of incomplete information. A Nash equilibrium of a complete information game is said to be robust to incomplete information if every incomplete information game with payoffs almost always given by the complete information game has an equilibrium which generates behavior close to the Nash equilibrium. We show that an open set of games has no robust equilibrium and examine why we get such different results from the refinements literature. We show that if a game has a unique correlated equilibrium, it is robust. Finally, a natural many-player many-action generalization of risk dominance is shown to be a sufficient condition for robustness. Download Paper
We consider a version of Kiyotaki and Wright's monetary search model in which agents can hold arbitrary amounts of divisible money. A continuum of stationary equilibriums, indexed by the aggregate real-money stock, exist with all trading occurring at a single price. There is always a maximum level of the real money stock consistent with existence of such an equilibrium. In the limit as trading becomes faster relative to discounting, any real money stock becomes feasible in such an equilibrium. In contrast to the original Kiyotaki-Wright model, higher equilibrium real money stocks unambiguously correspond to higher welfare. Download Paper
This paper shows that Nash equilibria of a local-interaction game are equivalent to correlated equilibria of the underlying game. Download Paper
It is well known from the Folk Theorem that infinitely repeated games admit a multitude of equilibria. This paper demonstrates that in some types of games, the Folk Theorem form of multiplicity is an artifact of the standard representation which assumes perfect synchronization in the timing of actions between the players. We define here a more general family of repeated settings called renewal games. Specifically, a renewal game is a setting in which a stage game is repeated in continuous time, and at certain stochastic points in time determined by an arbitrary renewal process some set of players may be called upon to make a move. A stationary, ergodic Markov process determines who moves at each decision node. We restrict attention in this paper to a natural subclass of renewal games called asynchronously repeated games, in which no two individuals can change their actions simultaneously. Special cases include the alternating move game, and the Poisson revision game. In the latter, each player adjusts his action independently at Poisson distributed times. Our main result concerns asynchronously repeated games of pure coordination (where the pay­ offs of all players in the stage game are identical up to an affine transformation): given € > 0, if players are sufficiently patient then every Perfect equilibrium payoff comes within € of the Pareto dominant payoff. We also show that the "Folk wisdom" in the standard model that repetition always expands (weakly) the set of equilibrium payoffs is not true generally in asynchronously repeated games. Download Paper
We develop a simple model that captures a concern for relative standing. The concern for relative standing is instrumental in the sense that individ­ uals do not get utility directly from their relative standing, but rather, the concern is induced because relative standing affects consumption of stan­ dard commodities. We investigate the consequences of a concern for relative wealth in models in which individuals are making labor-leisure choice deci­ sions. Among the results, we show how individuals' decisions are affected by the aggregate income distribution and how the concern for relative wealth can generate behavior that can be interpreted as conspicuous consumption when wealth is not directly observable. Download Paper
As traders learn about the true distribution of some asset's dividends, a speculative premium occurs as each trader anticipates the possibility of re-selling the asset to another trader before complete learning has occurred. Reasonable ignorance priors lead to large bubbles during the learning process. This phenomenon explains a paradox concerning the pricing of initial public offerings. The result casts light on the significance of the common prior assumption in economic models. Download Paper
This paper established the generic existence of sunspot equilibria in a standard two period exchange economy with real assets. We show that for a generic choice of utility functions and endowments, there exists an open set of real asset structures whose payoffs are independent of sunspots such that the economy with this asset structure has a regular sunspot equilibrium. This results also clarifies the relationship between equilibrium multiplicity and existence of sunspot equilibria. Our technique is very general and can be applied to other frameworks as the overlapping generations model with sunspots. Download Paper
This paper studies the robustness of a competitive equilibrium against sunspots, or endogenous uncertainty. It is shown that an equilibrium is robust if and only if it is sequentially regular. Download Paper
This paper studies the efficiency of policy choice in representative democ- racies. It extends the model of democratic policy making developed in our earlier paper (Besley and Coate (1995)) to a simple dynamic environment. Equilibrium policy choices are shown to be efficient in the sense that in each period, conditional on future policies being selected through the democratic process, there exists no alternative current policy choices which can raise the expected utilities of all citizens. However, policies which would be declared efficient by standard economic criteria are not necessarily adopted in political equilibrium. The paper argues that these divergencies are legitimately viewed as "political failures". Download Paper
A consumer with diminishing marginal utility in consumption, who can search for lower prices, will balance the gains from spreading consumption evenly through time against the bene ̄ts of delaying consumption until lower prices are revealed. Optimal programs of consumption, savings and price are characterized for a general formulation of this problem. Intertempo- ral substitutability is measured by relative-risk aversion. That relative-risk aversion that is small is su±cient for the intuitive solution: As the best current price rises, more search and less consumption is done. The general model is adapted to special cases. Among other things, this shows that lin- ear utility and sequential search implies ex ante calculable reservation prices and consumption only when search stops. However, this characterization is a consequence of the restriction to linear utility. Outside of this context reservation prices and consumption may not be calculable, ex ante. Download Paper
Kalai and Lehrer (93a, b) have shown that if players' beliefs about the future evolution of play is absolutely continuous with respect to play induced by optimal strategies then Bayesian updating eventually leads to Nash equilibrium. In this paper, we present the first set of necessary and su±cient conditions that ensure that Bayesian updating eventually leads to Nash equilibrium. More important, we show that absolute continuity does not rule out any observable behavior that is asymptotically consistent with Nash equilibrium. Download Paper
This paper analyzes the economic consequences of a±rmative action in the presence of statistical discrimination. In the model, workers with di®ering abilities have com- parative advantages in jobs with di®ering complexities. Employers, having a biased belief on the ability of minority workers, require higher credentials when promoting them to more productive jobs, which discourages their human capital investment. When a±rmative action policy is enforced, some under-quali ̄ed minority workers are promoted to di±cult jobs. Those workers, as well as some majority workers who are over-quali ̄ed for, but have to take, easy jobs lose because their comparative advan- tages are not utilized. This ine±ciency due to mismatch is not necessarily outweighed by the long term gain brought about by the policy, if groups di®er substantially in their human capital investment costs. Appropriately reinterpreted, the model explains why drop-out rates and the returns to college education di®er between blacks who attend black and non-black colleges. Download Paper
If players cannot perfectly synchronize their actions in co-ordination games, the efficient equilibrium is never achieved. Download Paper