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We examine a market in which firms confront a moral hazard problem in the provision of product quality, facing a short-term incentive to produce low quality but potentially earning higher profits from “committing” to high quality. There are two types of firms in the market, “inept” firms who can produce only low quality, and “competent” firms who have a choice between high and low quality. Firms occasionally leave the market, causing competent and inept potential entrants to compete for the right to inherit the departing firm’s reputation. In a repeated interaction, with consumers receiving noisy signals of product quality, competent firms choose high quality in an attempt to distinguish themselves from inept firms. Competent firms find average reputations most valuable in the sense that a competent firm is most likely to enter the market by purchasing an average reputation, in the hopes of building it into a good reputation, than either a very low reputation or a very high reputation. Inept firms , in contrast, find it profitable to either buy high reputations and deplete them or buy low reputations. Download Paper
We construct a model in which a firm’s reputation must be built gradually, is managed, and dissipates gradually unless appropriately maintained. Consumers purchase an experience good from a firm whose unobserved effort affects the probability distribution of consumer utilities. Consumers observe private, noisy signals (consumer utilities) of the behavior of the firm, yielding a game of imperfect private monitoring. The standard approach to reputations introduces some “good” or “Stackelberg” firms into the model, with consumers ignorant of the type of the firm they face and with ordinary firms acquiring their reputations by masquerading as Stackelberg firms. In contrast, the key ingredient of our reputation model is the continual possibility that the ordinary or “competent” firm might be replaced by a “bad” or “inept” firm who never chooses the Stackelberg action. Competent firms then acquire their reputations by convincing consumers that they are not inept. Building a reputation is an exercise in separating oneself from inept firms who one is not, rather than pooling with Stackelberg firms who one would like to be. We investigate how a firm manages such a reputation, showing, among other features, that a competent firm may not always choose the most efficient effort level to distinguish itself from an inept one. Download Paper
We study a simple model of pre-electoral opinion formation that posits that interaction between neighbouring voters leads to bandwagons in the dynamics of the individual process, as well as in that of the aggregate process. We show that in different specifications of the model, there is a tendency for the process to show consensus, i.e. to approach a configuration of homogeneous support for one candidate, out of the two who run the electoral campaign. We point out that the process displays the feature that, after long time spans, a sequence of states occur which, when viewed locally, remain almost stationary and are characterized by large clusters of individuals of the same opinion. Download Paper
This paper studies a simple dynamic model of pre-electoral opinion formation, where individuals repeatedly form their opinions as to which (out of two) candidate to support. The behavioral rules we analyze allow for various forms of discontinuities, that we characterize in terms of threshold, and are defined in a locally interactive setting. We focus on both the long-run and short-run behavior of the process. It is shown that the asymptotics of the process depend crucially on the particular form of discontinuity that we postulate. In particular the process may show a tendency towards consensus, in the sense that all individuals conform in their opinion, or the system may be absorbed in configurations in which different opinions co-exist. We finally analyze various forms of asymmetries in the threshold. Download Paper
We discuss a fundamental trade-off in the political process that can lead to inefficient provision of public goods: politicians may not offer to provide socially desirable public goods because the benefits of the public good cannot be targeted to voters as easily as pork barrel spending. We study how this inefficiency is affected by alternative ways of conducting elections. We first compare a winner-take-all system with a proportional system. We then contrast two different ways of electing politicians to nationwide offices: one is majority rule, the other is the system used in U.S. presidential elections: the electoral college. Download Paper
In repeated games with imperfect public monitoring, players can use public signals to perfectly coordinate their behavior. Our study of repeated games with imperfect private monitoring focuses on the coordination problem that arises without public signals. We present three new observations. First, in a simple twice repeated game, we characterize the private signaling technologies that allow non-static Nash behavior in pure strategy equilibria. Our characterization uses the language of common p-belief due to Monderer and Samet (GDB, 1989). Second, we show that in the continuum action convention game of Shin and Williamson (GEB, 1996), for any full support private monitoring technology, equilibria of the finitely repeated convention game must involve only static Nash equilibria. By contrast, with sufficiently informative public monitoring, the multiplicity of Nash equilibria allows a finite folk theorem. Finally, for finite action games, we prove that there are full support private monitoring technologies for which a Nash reversion infinite horizon folk theorem holds. Download Paper
We consider a market in which there are two types of workers, “red” and “green,” where these labels have no direct payoff implications. Workers can choose to acquire costly skills. Skilled workers must search for firms with a job vacancy, while firms with vacancies also search for unemployed workers. A unique symmetric equilibrium exists in which firms ignore workers’ colors. There may also exist an asymmetric equilibrium in which firms only search for green worker, more green than red workers acquire skills, skilled green workers receive higher wage rates than skilled red workers, and the unemployment rate is higher among skilled red than green workers, though there are more unemployed skilled green workers than red workers. Discrimination between ex ante identical individuals thus arises as an equilibrium phenomenon. Our analysis differs from previous models of discrimination in assuming that firms have perfect information about workers with whom they are matched, and strictly prefer to hire minority workers (contingent on meeting a worker), and in generating predictions concerning unemployment as well as wage rates. Download Paper
The paper develops a framework for the analysis of finite n-player games, recurrently played by randomly drawn n-tuples of players, from a finite population. We first relate the set of equilibria of this game to the set of correlated equilibria of the underlying game, and then focus on learning processes modelled as Markovian adaptive dynamics. For the class of potential games, we show that any myopic-best reply dynamics converges (in probability) to a correlated equilibrium. We also analyze noisy best reply dynamics, where players’ behaviour is perturbed by payoff dependent mistakes, and explicitly characterize the limit distribution of the perturbed game in terms of the correlated equilibrium payoff of the underlying game. Download Paper
While most studies on immigration focus on its impact on the labor market, in this study we address its effect on socioeconomic gaps. By studying Israeli immigration,m we examine the effects of mass immigration on socioeconomic gaps among generations using the Israeli Censuses for 1961 and 1983. We look at the socioeconomic gaps within two difference economic systems within the same economy. One system is perfect competition oriented while the second, the kibbutz, is organized as a labor-managed firm. Both generations distinguished between the different ethnic groups and the parents' country of origin. In particular, three groups are examined, in the first generation using the 1961 census, those who were born in Asian and African countries, in European and American countries, and in Israel. In the second generation, using the 1983 census, we look at those whose fathers were born in the respective areas. The analysis decomposes the Occupation Socioeconomic Score (OSS) differentials into human capital and market evaluation differences for each generation separately. The model develops a gap function that quanti ̄es the socioeconomic gaps and uses iso-gap curves to compare pre-immigration and post-immigration gaps.The study finds that the score differentials among the examined groups in the kibbutz are lower than in the city, prior to the second wave of immigration. Even after the second wave of immigration the score differentials in the kibbutz, among the examined groups, are lower than in the city. We attempt to explain this occurrence by looking at how society in the kibbutz differs in the treatment of immigrants. In particular, we focus on how the kibbutz, because of its size and reward structure, is able to internalize certain externalities and aim at a relatively higher level of education for all. Download Paper
"No Trade" Theorems claim that the mere arrival of new information can not induce trade between rational agents, even in the presence of asymmetric information. We analyze an economy in which the information agents receive is without noise. As long as preferences abide by the Sure Thing Principle, the no-trade result holds. However, under more general preferences, which do not satisfy the Sure Thing Principle, we find that dynamic consistency is a necessary but might not be a sufficient condition for information not to induce trade, even with noiseless information. We provide sufficient conditions for a No-Trade. Theorem and investigate the pattern of trade with and without dynamic consistency of preferences. Download Paper
This paper shows that the economic policies of the US and Japan have led to disequilibrium in the pattern of trade. Both economies have built-in mechanisms tending towards equilibrium. However, with restrictive policies imposed by these countries, disequilibrium is perpetuated. The US "suffers" a trade deficit, while Japan enjoys" a trade surplus. Although a trade surplus has a positive connotation, the prevailing strong yen hurts the Japanese economy. With a more integrated world, countries can no longer be concerned solely about their own economies. The recession in Japan is partially caused by this large imbalance in trade since the strong yen is driving out many Japanese businesses that can no longer compete. The large government deficit in the United States will also affect the exchange rate and the rest of the world, since the possibility of a default may raise the interest rates as well as the level of uncertainty. Countries must cooperate with each other in order to allow the world economy to reach its equilibrium. Intervention polices require that the citizens in each country actually trust that governments are committed to resolve the enigma of the strong Yen (endaka). Without strong conviction by the public that the policy would be seriously implemented, the exchange rates will not change in the desired direction. Download Paper
Evolutionary game theory provides an answer to two of the central questions in economic modeling: When is it reasonable to assume that people are rational? And, when is it reasonable to assume that behavior is part of a Nash equilibrium (and if it is reasonable, which equilibrium)? The traditional answers are not compelling, and much of evolutionary modeling is motivated by the need for a better answer. Evolutionary game theory suggests that, in a range of settings, agents do (eventually) play a Nash equilibrium. Moreover, evolutionary modeling has shed light on the relative plausibility of different Nash equilibria. Download Paper
This paper documents the delayed adoption of a major technological innovation: the adoption of the diesel locomotive in the US rail­ way industry. Contrary to other instances of major technological innovations, the delay in the adoption of the diesel locomotive was not associated with an initial slump in output. We provide a theoretical model which is consistent with both an increase and a decrease in output following the invention of a new technology. Within this model we identify the key factors that make a slump in output unlikely. Download Paper
In this paper, we model the dynamic portfolio choice problem facing banks, calibrate the model using empirical data from the banking industry for 1984-1993, and assess quantitatively the impact of recent regulatory. developments related to bank capital. The model suggests that the new regulatory environment may have the unintended consequence of inducing banks, especially undercapitalized ones, to invest in riskier assets. This holds both under higher capital requirements (even if risk-based) and under capital-based deposit-insurance premia. Download Paper
A Common Interest game is a game in which there exists a unique vector of payoffs which strictly Pareto-dominates all other payoffs. We consider the undiscounted repeated game obtained by the infinite repetition of such an n-player Common Interest game. We restrict supergame strategies to be computable within Church's thesis, and we introduce computable trembles on these strategies. If the trembles have sufficiently large support, the only equilibrium vector of payoffs which survives is the Pareto-efficient one. The result is driven by the ability of the players to use the early stages of the game to communicate their intention to play cooperatively in the future. The players 'take turns' to reveal their cooperative intentions, and the result is proved by 'backwards induction' on the set of players. We also show that our equilibrium selection result fails when there are a countable infinity of players. Download Paper
Most economists are sympathetic to the idea that concerns for relative position are an important aspect of many economic problems. There has traditionally been a reluctance to include such concerns primarily because models that included them often allow such a broad range of behavior that there are few, if any, restrictions on equilibrium behavior and, hence, such models would have little or no predictive power. In this paper we discuss how reduced form models may naturally give rise to utility functions that depend, in part, on relative standing. There are several advantages of modelling concern for relative standing in reduced form utility functions even when there is no similar concern in the "deep" preferences. It provides structure and constraints on the way that relative standing affects utility, and further, it can yield testable implications about the way that changes in the underlying environment affect the concern for relative standing. We discuss the advantages and disadvantages of modelling social concerns in this way and provide examples that illustrate how concerns for relative standing can affect savings, investment and labor choice decisions. Download Paper
We develop a model of firm size in which firms are unable to access as many consumers as they want. Newly arrived consumers match randomly with firms. Subsequently, consumers must pay search costs to be able to switch firms. This cost promotes an inertial tendency for consumers to remain with the ̄rm they currently buy from. Consequently, established firms enjoy a proprietary relationship with respect to their old customers while new entrants only have access to first time consumers, who are as yet unattached to any firm. As time goes on, firms acquire successive generations of new consumers, and their stock of loyal customers grows gradually. Thus, more senior firms command higher market shares. We construct an industry model based on this hypothesis and show that the aggregate implications of the model are consistent with empirical facts about industry dynamics (e.g., Dunne, Roberts and Samuelson, (1988, 1989) or Davis and Haltiwanger (1992)): Larger and older firms are less likely to exit than younger and smaller firms. In our model this results from the fact that the option value of remaining operative in the aftermath of a high cost-shock is greater for an older firm than for a younger firm because the value of a cost turnaround is greater for the former (which has already accumulated a large customer-base) than for the latter (which has yet to do so). This enables older (and larger) firms to survive adverse cost-shocks which force the exit of younger (and smaller) firms. For similar reasons, R&D expenditures are larger for larger firms, as per the empirical findings surveyed by Cohen and Lewis (1989). Download Paper
This paper examines the effect of competition on firms’ efforts to experiment and learn about market demand. Consumers are assumed to know prices only at sellers they have actually visited, but must bear search costs to find the prices of other sellers. Under these conditions we show that firms’ incentives to experiment are diluted by comparison with the monopoly case and that this effect is stronger the smaller the search cost. The learning environment we portray gives rise to several time paths which have been empirically documented, including penetration pricing, cream-skimming and cyclical pricing. Download Paper
We identify and investigate the basic 'hold-up problem' which arises whenever each party to a contract has to pay some ex-ante cost for the contract to become feasible. We then proceed to show that, under plausible circumstances, a 'contractual solution' to this hold-up problem is not available. This is because a contractual solution to the hold-up problem typically entails writing a 'contract over a contract' which generates a fresh set of ex-ante costs, and hence is associated with a new hold-up problem. Download Paper
In this paper we examine the dynamic resolution of technological adoption in "hardware/software" systems. We are interested in determining to what extent software availability affects hardware sales and/or vice-versa. We first develop a dynamic model for estimating demand when costs (and hence prices) are declining over time. We then estimate it empirically for the case of compact disc players. We ̄find that there is "two-way" feedback between hardware and software for compact disc players. The result that the availability of compatible software (the CDs) plays a significant role in determining the adoption of compact disc players is likely due in part to the fact that compact disc players were not compatible with any existing audio standard. Download Paper
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