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In a static economy with symmetric information, the informational requirements for competitive equilibrium are very weak: markets clear and each agent is rational. With asymmetric information, the solution concept of competitive equilibrium has been generalized to rational expectations equilibrium. But now common knowledge of market clearing and rationality is required. This paper proves versions of these results in a formal model of knowledge. Download Paper
At a rational expectations equilibrium (REE), individuals are assumed to know the map from states to prices. This hypothesis has two compo- nents, that agents agree (consensus), and that they have point expectations (degeneracy). We consider economies where agents' beliefs are described by a joint distribution on states and prices, and these beliefs are ful ̄lled at equilibrium. Beliefs are self-ful ̄lling if every price in the support of the distribution is an equilibrium price. The corresponding equilibria are Beliefs Equilibria (BE). The further restriction that agents have the same beliefs results in Common Beliefs Equilibria (CBE). We study the relation- ship between BE, CBE, and REE, thus isolating the role of consensus and of degeneracy in achieving rational expectations. Download Paper
This paper develops a new approach to the study of democratic policy making where politicians are selected by the people from those citizens who present themselves as candidates for public office. Participation in the policy making process is, therefore, derived endogenously. The approach has a number of attractive features. First, it is a conceptualization of a pure form of representative democracy in which government is by, as well as of, the people. Second, the model is analytically tractable, being able to handle multidimensional issue and policy spaces very naturally. Third, it provides a vehicle for answering questions about the achievements of representative democracy. We study, in particular, whether representative democracy produces efficient outcomes. Download Paper
This paper analyzes an incomplete financial markets model with price- taking utility-maximizing financial innovators and no-short sales restrictions. It is shown that, given the indeterminacy of the no arbitrage price conjecture of innovators, financial markets can remain incomplete in equilibrium. As a consequence, real indeterminacy of degree at least equal to int (S/2)(S- (S/2)) results, where S is the number of spots in the future. The dimension of innovators’ beliefs giving rise to I newly introduced financial assets is I(S-I), with an equal degree of real indeterminacy. Download Paper
We consider the problem of two agents bargaining over the relative price of two goods they are endowed with. They alternatingly exchange price offers and the utilities are discounted. The recipient of an offer can either accept it and choose the quantities to be traded, or reject and counter- offer a different relative price. We study the set of equilibria as discounting frictions vanish and find that: (1) any generic economy has bargaining equilibria that are inefficient even as discounting frictions vanish; and (2) a bargaining equilibrium converging to a Walrasian outcome exists for some robust types of convergence of the discount factors, but it does not exist for other equally robust convergences. Moreover, in case there exists a bargaining equilibrium converging to a Walrasian outcome, then there is necessarily a multiplicity of them. As a consequence, unlike in Rubinstein’s (1982) alternating-offer bargaining, the equilibrium outcome of this set-up is not generically unique and efficient. Download Paper
We study a dynamic moral hazard model where the agent does not fully observe his performance. We consider the incentive effects of providing feedback to the agent: revealing to the agent how well he is doing. We show that, if the incentive scheme is exogenously given, there is a wide range of cases where the agent works harder if feedback is provided. However, the agent earns more money in this scenario. We then characterize the optimal incentive schemes in the two scenarios and we show that the principal is better off if feedback is not provided; the expected cost of inducing any given level of expected effort is lower in the no-revelation scenario. Download Paper
This paper surveys the significance of recent work on emulative neural networks (ENNs) by researchers across many disciplines in the light of issues of indeterminacy. Financial and economic forecasters have witnessed the recent development of a number of new forecasting models. Traditionally, popular forecasting techniques include regression analysis, time-series analysis, moving averages and smoothing methods, and numerous judgmental methods. However, all of these have the same drawback insofar as they require assumptions about the form of population distribution. Regression models, for example, assume that the underlying population is normally distributed. ENNs are members of a family of statistical techniques, as are flexible nonlinear regression models, discriminant models, data reduction models, and nonlinear dynamic systems. They are trainable analytic tools that attempt to mimic information processing patterns in the brain. Because they do not necessarily require assumptions about population distribution, economists, mathematicians and statisticians are increasingly using ENNs for data analysis. Download Paper
We base a contracting theory for a start-up firm on an agency model with observ- able but nonverifiable effort, and renegotiable contracts. Two essential restrictions on simple contracts are imposed: the entrepreneur must be given limited liability, and the investor’s earnings must not decrease in the realized profit of the firm. All message game contracts with pure strategy equilibria (and no third parties) are considered. Within this class of contracts/equilibria, and regardless of who has the renegotiating bargaining power, debt and convertible debt maximize the entrepre- neur’s incentives to exert effort. These contracts are optimal if the entrepreneur has the bargaining power in renegotiation. If the investor has the bargaining power, the same is true unless debt induces excessive effort. In the latter case, a non-debt simple contract achieves efficiency — the non-contractibility of effort does not lower welfare. Thus, when the non-contractibility of effort matters, our results mirror typ- ical capital structure dynamics: an early use of debt claims, followed by a switch to equity-like claims. Download Paper
A simple model incorporating rent-seeking into the standard neoclassical model of capital accumulation is presented. It embodies the idea that the performance of an economy depends on the efficiency of its institutions. It is shown that welfare is positively affected by the institutional efficiency, although output is not necessarily so. It is also shown that an economy with a monopolistic rent-seeker performs better than one with a competitive rent-seeking industry. Download Paper
This paper asks to what extent distortions to the adoption of new technology cause income inequality across nations. We work in the framework of embodied technological progress with an individual, C.E.S. production function. We estimate the parameters of this production function from international data and calibrate the model, using U.S. National Income statistics. Our analysis suggests that distortions account for a bigger portion of income inequality than hitherto has been assessed. Download Paper
This paper explores the distortions on the cost of education, associated to government policies, as an additional determinant of cross-country income differences. Human capital follows a Mincerian approach and accumulation of skills is done at school) outside the labor market. There are two sectors, one producing goods and the other providing educational services. The model is calibrated and simulated for 122 economics. We find that human capital taxation has a relevant impact on incomes, which is amplified by its indirect effect on returns to physical capital. For comparable values, distortions to the latter have an overall effect on incomes smaller than human capital taxation. Life expectancy plays an important role in determining long-run output: the expansion of the population working life increases the present value of the flow of wages, which induces further human capital investment and raises incomes. A general conclusion, however, is that there is not a single cause for the poverty of nations. Some are poor because of very low productivity, and others because of excess taxation on factors. Download Paper
We develop a model in which the value of a firm’s reputation for quality increases gradually over time. In our model, a firm’s ability to deliver high quality at any given period depends on how much it invests in quality. This investment is the firm’s private information. Also, a firm’s current quality is unobservable. Thus the only observable is a firm’s past performance - the realized quality of the products it delivered. We assume that information about a firm’s past performance diffuses only gradually in the market. Thus, the longer a firm has been delivering high-quality products, the larger the number of potential customers, which are aware of it. We show that in equilibrium, the firm’s investment in quality increases over time, as its reputation - the number of consumers who are aware of its history - increases. This is because the greater its reputation, the more it has to lose from tarnishing it by under-investing and, conversely, the more it has to gain from maintaining it. This is recognized by rational consumers. Therefore, older - and hence larger firms - command higher prices as quality premia. This in turn feeds back into firms’ investment incentives: the fact that they are able to command higher prices motivates older and larger firms to invest and larger a firm is, the more valuable an asset its reputation is. Download Paper
One consequence of dynamic system theory is that relatively simple systems, which can be described by a few non-linear equations, can exhibit very complicated, stochastic-like behavior. Such models simulate processes inexpensively. They reveal insights into the underlying mechanisms while devising strategies to control these processes. Chaotic systems are sensitive to initial conditions. Since these conditions are not precisely known and are subject to perturbations, long-term predictions of the behavior of these systems are impossible. Thus, the availability of large computational resources will not enable one to generate long-term predictions for systems ranging from weather to economic forecasts. Download Paper
A striking characteristic of high-tech products is the rapid decrease of their quality-adjusted prices. Empirical studies show that the rate of decrease of QAPs is typically not constant over time; QAPs decrease rapidly at early stages of the product and then the rate of decrease tapers off. Studies also suggest that the QAP is positively correlated with the rate of product introductions: The faster new products are introduced, the faster is the rate of decrease in their QAPs. This paper presents a dynamic model of product innovations consistent with these empirical regularities. Download Paper
This paper re-examines the conditions for the existence of local stationary sunspot equilibria (SSE) in the standard OLG model from a broader perspective than before. We say that local SSE exist around a steady state of a given OLG economy if, in any arbitrarily small neighborhood of the steady state, we can find a SSE of a “nearby” economy. We show that when the domain where “nearby” economies may lie is defined by agents’ endowments and probabilities, the indeterminacy of the steady state remains both necessary and sufficient for the existence of local SSE. On the other hand, when the domain of economies is defined by by agents’ preferences and probabilities, local SSE may exist even around determinate steady states. We also show that if a slightly weaker notion of distance is used to identify “nearby” economies, SSE in the vicinity of a steady state equilibrium generically exist. Download Paper
We argue that one of the key channels linking the labor and marriage markets is the decision of when to become a parent. We develop an equilibrium model of marriage, divorce, and human capital accumulation that allows for differential timing of fertility. We calibrate the model to US panel data and analyze the effects of raising women’s wages relative to men’s, and increasing the rate of return to experience for women. We find that an increase in the returns to experience for women is causes an increase in fraction of children born to women over age 30, and that raising women’s wages reduces marriage rates. Download Paper
This paper examines the interactions between household matching, inequality, and per capita income. We develop a model in which agents decide whether to become skilled or unskilled, form households, consume and have children. We show that the equilibrium sorting of spouses by skill type (their correlation in education) is increasing as a function of the skill premium. In the absence of perfect capital markets, the economy can converge to different steady states, depending upon initial conditions. The degree of marital sorting, wage inequality, per capita income and fertility differentials are positively correlated across steady states. We use household surveys from 34 countries to construct several measures of the skill premium and of the degree of correlation of spouses' education (marital sorting). For all our measures, we find a positive and significant relationship between the two variables. Download Paper
In this paper, we propose an answer to the following question: if Canada had adopted a social policy similar to that which prevailed until recently in the U.S., would Canada’s income distribution and rate of single-parenthood have looked more like those of the US? Our answer is based on simulations of the Canadian economy under the two alternative social policies, and thus rules out noise from other variations between the two policy regimes. We find that U.S.-style transfer policies can indeed account for most of the higher rate of single-parenthood in the U.S. The Canadian policy is also more effective in alleviating poverty: the poorest 20% of the population are significantly worse off under the U.S. policy. Download Paper
This paper studies the characteristics of thirteen small European stock markets, in order to find international support for the presence of efficiency in financial markets. The thirteen bourses are located in Belgium, Denmark, Finland, Greece, Ireland, Luxembourg, Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and Turkey. The paper tests the Overreaction and Uncertain Information Hypotheses by examining the behavior of these markets over a 60-day period following positive or negative market disruptions. The conclusions are that for this particular time lag most small European stock markets operate under efficient conditions. Download Paper
This paper considers the efficiency and convergence properties of dynamic processes of social and economic interactions such as exchange economies, multilateral negotiations, merger and divestiture transactions, or legislative bargaining. The key general feature of the economy is that agents can implement any move from one state to another as long as a pre-specified subset of agents approve of it. By means of examples, we show that inefficiencies may occur even in the long run. Persistent inefficiencies take the form of cycles between states or of convergence to an inefficient state. When agents are sufficiently patient, we show very generally that the initial state from which the process starts plays no role in the long run properties of equilibria. Also, when there exists an efficient state that is externality free (in the sense that a move away from that state does not hurt the agents whose consent is not required for the move), then the system must converge to this efficient state in the long run. Conversely, long run efficiency can only be attained in a robust way if there exists an efficient externality-free state. It is thus more important to design transitions guaranteeing the existence of an efficient externality-free state rather than to implement a fine initialization of the process. Download Paper
The Middle East Stock exchanges are becoming attractive due to the unprecedented decrease of information costs. Employing Vector Auto Regression (VAR) and Bayesian VAR models to trace the dynamic co movements among the stock indices for the emerging Middle East and the major index of the United States market. The Middle East countries included are: Egypt, Israel, Jordan, Lebanon, Morocco, Oman, and Turkey. Monte Carlo simulations trace the effects of transmission of innovations from one market to other. The dynamic linkages among these stock markets are relatively small, suggesting benefits to investors who would like to improve on their portfolio. Download Paper
Random Walk and Efficient Market Hypotheses are central ideas in explaining financial market efficiencies. The assumption that market behavior embodies and reflects relevant information has a great impact on securities prices. Any change in the relevant information causes price adjustment. In contrast, technical analysts argue that prices gradually adjust to new information. Thus, historical analysis is useful in diagnosing the repeated pattern behaviors leading to active investment strategies that generate better- than-market returns. The purpose of this study is to examine the efficacy of using technical trading rules in the emerging market of Israel, through the analysis of the Tel-Aviv 25 Index (TA25) and to compare its weak-form market efficiency to the performance of the S&P 500. Download Paper
This paper considers a class of two players games in the unit square for which a similar and high enough responsiveness of each player’s strategy to the other player’s strategy around a Nash equilibrium in pure strategies implies (i) the existence of at least two other Nash equilibria in pure strategies; (ii) the non local uniqueness of the strategies of this Nash equilibrium in the sets of rationalizable strategies; and (iii) the existence of nontrivial correlated equilibria arbitrarily close to this Nash equilibrium. Although a similar result can be shown to follow from Milgrom and Roberts’ (1990) results for supermodular games, the games considered here are not necessarily supermodular, which makes clear that supermodularity is not necessary to obtain it. The simultaneous emergence of phenomena of multiplic- ity, instability and vulnerability to sunspots studied in this paper parallels similar patterns observed in other frameworks (e.g. overlapping generations economies and finite economies with asymmetric information), and thus hints at the existence of an underlying relation between different avatars of the indeterminacy of the outcome of economies and games that goes beyond the boundaries of any specific framework and may be common to every decision-making problem faced of simultaneous, independent and interrelated optimizers. Download Paper
We compare the rates of product innovation under rental versus sales when the product is durable and the market structure is one of duopoly. Our main conclusion is that sales induce a slower and more efficient rate of product introductions than rentals. The basic reason for this is that under rentals sellers are able to extract a higher surplus from buyers, and this higher surplus is dissipated away through excessive rate of product innovation. Since the exact opposite is true under monopoly market structure this highlights the role of market structure in determining the rate of product innovations when the product is durable. Download Paper
This paper demonstrates that the applied monetary models - the Sidrauski-type models and the cash-in-advance models, augmented with a banking sector that supplies money substitutes services - imply trajectories which are Pareto-Optimum restricted to a given path of the real quantity of money. As a consequence, three results follow. First, Bailey's formula to evaluate the welfare cost of inflation is indeed accurate, if the long-run capital stock does not depend on the inflation rate and if the compensate demand is considered. Second, the relevant money demand concept for this issue - the impact of inflation on welfare - is the monetary base. Third, if the long-run capital stock depends on the inflation rate, this dependence has a second-order impact on welfare, and, conceptually, it is not a distortion from the social point of view. These three implications moderate some evaluations of the welfare cost of the perfect predicted inflation. Download Paper
This paper studies multilateral negotiations among n players in an environment where there are externalities and where contracts forming coalitions can be written and renegotiated. The negotiation process is modeled as a sequential game of offers and counteroffers, and we focus on the stationary subgame perfect equilibria, which jointly determine both the expected value of players and the Markov state transition probability that encodes the path of coalition formation. The existence of equilibria is established, and Pareto efficiency is guaranteed if the grand coalition is efficient, despite the existence of externalities. Also, for almost all games (except in a set of measure zero) the equilibrium is locally unique and stable, and the number of equilibria is finite and odd. Global uniqueness does not hold in general (a public good provision example has seven equilibria), but a sufficient condition for global uniqueness is derived. Using this sufficient condition, we show that there is a globally unique equilibrium in three-player super-additive games. Comparative statics analysis can be easily carried out using standard calculus tools, and some new insights emerge from the investigation of the classic apex and quota games. Download Paper
This paper develops a dynamic model of tender offers in which there is trading on the target's shares during the takeover, and bidders can freeze out target shareholders (compulsorily acquire remaining shares not tendered at the bid price), features that prevail on almost all takeovers. We show that trading allows for the entry of arbitrageurs with large blocks of shares who can hold out a freezeout - a threat that forces the bidder to offer a high preemptive bid. There is also a positive relationship between the takeover premium and arbitrageurs' accumulation of shares before the takeover announcement, and the less liquid the target stock, the strong this relationship is. Moreover, freezeouts eliminate the free-rider problem, but front-end loaded bids, such as two-tiered and partial offers, do not benefit bidders because arbitrageurs can undo any potential benefit and eliminate the coerciveness of these offers. Similarly, the takeover premium is also largely unrelated to the bidder's ability to dilute the target's shareholders after the acquisition, also due to potential arbitrage activity. Download Paper
We consider a repeated duopoly game where each firm chooses its investment in quality, and realized quality is a noisy indicator of the firm's investment. We derive reputation equilibria, whereby consumers `discipline' a firm by switching to its rival in case its realized quality is too low. The model predicts that firms with good reputation charge a higher price, sell a bigger quantity and have a higher stock-market capitalization. Every so often, the market is subjected to turnover, whereby the highquality / good reputation firm loses market share, lowers its price and its capitalization suffers, while its rival gains market share, raises its price and enjoys increased capitalization. We examine properties of reputation equilibria. In particular, we show that the equilibrium is not efficient or nearly efficient even as the discount factor goes to 1. Download Paper
We present three examples of finitely repeated games with public monitoring that have sequential equilibria in private strategies, i.e., strategies that depend on own past actions as well as public signals. Such private sequential equilibria can have features quite unlike those of the more familiar perfect public equilibria: (i) making a public signal less informative can create Pareto superior equilibrium outcomes; (U) the equilibrhun finalperiod action profile need not be a stage game equilibrium; and (iii) even if the stage game has a unique correlated (and hence Nash) equilibrium, the first-period action profile need not be a stage game equilibrium. Download Paper
Citizens of two racial groups choose whether to engage in illegal activities, and police audit citizens. Citizens are heterogeneous according to legal earning opportunities, which are distributed differently across groups. We define fairness of policing as policing groups with the same intensity, and effectivenesss of interdiction as reducing the amount of crime. We show that sometimes, forcing the police to behave more fairly can increase effectiveness of interdiction, and give exact conditions under which this is so. These conditions are based on the distributions of legal earning opportunities in the two groups, and are expressed as contraints on the QQ plot of these distributions. Legal earning opportunities are not observable for those citizens who become criminals. However, we give conditions under which the QQ plot of legal earning opportunities equals the QQ plot based on reported income distributions (which are observable). We also discuss whether our notion of fairness is meaningful when the cost of being searched reflects the shame of being singled out by the police. Download Paper
In this paper we consider a two-period general equilibrium model with uncertainty and real assets as financial instruments. The novelty of the analysis is that real assets are the stock of neoclassical firms, so that both returns and yields depend on anticipated spot goods prices (and, of course, the yield matrix may change rank with prices). Assuming that financial markets are potentially complete, we establish generic existence of financial equilibrium and prove that there exists a dense set of economies such that financial equilibria are efficient. Download Paper
We study strategic three-player coalitional bargaining problems in an environment with externalities where contracts forming coalitions can be written and renegotiated. The theory yields a unique stationary subgame perfect Nash equilibrium outcome (the coalitional bargaining value). This solution has an intuitive economic interpretation using outside options, and it can be either the Nash bargaining solution, for games where the worth of all pairwise coalition is less than a third of the grand coalition value; the Shapely value, for games where the sum of the values created by all pairwise coalitions is greater than the grand coalition value; or the nucleolus, for games where only the 'natural coalition' among two 'natural partners' creates significant value, and those where only the pairwise coalitions including 'a pivotal player' create significant value. Download Paper
This paper identifies a new corporate governance mechanism: sharing control. We show that bargaining problems among multiple controlling shareholders may prevent inefficient investment decisions that harm minority shareholders. The same bargaining problems may block efficient investment decisions, though. By solving this trade-off, we show that the likelihood that shared control is efficient increases with three firm characteristics: overinvestment problems, the cost of verifying cash flows, and financing requirements. The model provides testable implications for the role that large shareholders play in corporate governance, contrasting shared control and monitoring as alternative governance mechanisms. Download Paper
The increasing hazard rate (IHR) property of distributions of asymmetric information parameters play a critical role in characterizing a separating Perfect Bayesian–Nash Equilibria in screening problems. This paper studies sufficient conditions on these distributions for IHR to be preserved under convolution. When different sources of asymmetric information aggregate into a single scalar, these preservation results prove very useful in designing alternative optimal mechanisms. The paper proves that if the distributions of all convoluting parameters are IHR the resulting distribution is also IHR. This result does not necessarily requires that the corresponding densities have to be log–concave. Download Paper
We explore entry into a foreign market with uncertain demand growth. A multinational can serve the foreign demand by two modes, or by a combination thereof: it can export its product, or it can create productive capacity via Foreign Direct Investment. The advantage of FDI is that it allows lower marginal cost than exports. The disadvantage is that FDI is irreversible and, hence, entails the risk of creating under-utilized capacity in case the market turns out to be smaller than expected. The presence of demand uncertainty and irreversibility gives rise to an interior solution, whereby the multinational does - under certain conditions - both exports and FDI. We argue that this feature is consistent with observed behavior of multinationals, yet it has not arisen in previous theoretical formulations. Download Paper