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We consider a risk-neutral, price-taking and value-maximizing firm under demand uncertainty. The firm chooses optimal investment strategies; the investment is irreversible. For a wide family of non-Gaussian processes, we derive an explicit formula for the boundary of the inaction region by using the Wiener-Hopf factorization method. As an application of the method, we suggest a Marshallian-like form for the investment rule. It is applicable when the price can move in both directions, and uses the infimum process of the price instead of the price process itself. We also write down an analytic formula for the expected level of the capital stock in terms of the infimum and supermum processes. Both results are new even for the Gaussian case. Download Paper
We examine the ex ante incentive compatible core, and show that generically, when agents are informationally small in the sense of McLean and Postlewaite (1999), the ex ante incentive compatible core is nonempty. Download Paper
This paper studies a class of multidimensional screening models where different type dimensions lie on the real line. The paper applies preservation results of totally positive functions to show that some critical properties of the distributions of asymmetric information parameters, such as increasing hazard rate, monotone likelihood ratio, and unimodality are preserved under convolution and/or composition. Under some general conditions, these preservation results also provide a natural ordering of alternative screening mechanisms. These results explain the optimality of bundling solutions in a wide range of economic models based on distributional features of the informational parameters involved. Download Paper
We study a dynamic principal-agent problem where social capital is an important part of the system of incentives. In each period the firm chooses an incentive intensity, and its employees allocate effort between individual and cooperative tasks. Cooperative tasks are within bounds -more productive than individual tasks, but employees are not monetarily rewarded for them. Rather, and consistent with recent work in experimental economics, employees allocate effort to cooperative tasks because they derive utility from cooperation. The utility from cooperation is endogenously de-termined, and depends on how much others have cooperated in the past and on the firm's incentive intensity. Consequently, the cooperativeness of the workforce, which we also call the firm's "social capital," follows a dynamic process where the incentive intensity acts as a control variable. We show that the optimal choice of incentives can create cultural differences across firms. Download Paper
We describe the maximum efficient subgame perfect equilibrium payoff for a player in the repeated Prisoners' Dilemma, as a function of the discount factor. For discount factors above a critical level, every efficient, feasible, individually rational payoff profile can be sustained. For an open and dense subset of discount factors below the critical value, the maximum efficient payoff is not an equilibrium payoff. When a player cannot achieve this payoff, the unique equilibrium outcome achieving the best efficient equilibrium payoff for a player is eventually cyclic. There is an uncountable number of discount factors below the critical level such that the maximum efficient payoff is an equilibrium payoff. Download Paper
We develop a theoretical framework for comparing the style of work in public and private enterprises. We incorporate "socializing," an activity which yields utility for workers and affects a firm's output, into a simple multitask model of work organization. In contrast with previous models, we establish the two following results. First, the optimal workers' compensation policy displays a larger incentive intensity in the private firm than in the public firm. Second, labor productivity in the private firm may be higher or lower than in the public firm. Both results fit well with the findings of empirical work. Download Paper
A key question concerning social norms is whether norms, that are bad for its members, can survive. This paper proposes a theory of non-market interactions within organizations, in the presence of competition between them. The main finding is that in equilibrium, organizations differ, and that they have norms or corporate cultures that can be Pareto ranked. With non contractible effort, agents cannot credibly commit to cooperation when all outside options are equally good. Price competition naturally gives rise to authority relations within firms: seniors extract higher rents than entering juniors. However, authority is limited by competition and does not eradicate the stratification of norms. Download Paper
This paper considers equilibrium directed search with a finite number of heterogeneous workers and firms, where firms compete in direct mechanisms. Unlike previous findings, Nash equilibrium here does solve the problem of coordination failure. Restricting the match value function to be supermodular, and that firms use truthful strategies also imply positive assortative matching and decentralized trading prices which are consistent with the stable (cooperative equilibrium) outcome. The equilibrium mechanism is not an auction. Instead, to attract better skilled workers, firms post a fixed wage rule and hire the most skilled applicant who applies. Download Paper
We analyze infinitely repeated prisoners' dilemma games with imperfect private monitoring, and construct sequential equilibria where strategies are measurable with respect to players' beliefs regarding their opponents' continuation strategies. We show that, when monitoring is almost perfect, the symmetric efficient outcome can be approximated in any prisoners' dilemma game, while every individually rational feasible payoff can be approximated in a class of prisoner dilemma games. We also extend the approximate efficiency result to n-player prisoners' dilemma games and to prisoner's dilemma games with more general information structure. Our results require that monitoring be sufficiently accurate but do not require very low discounting. Download Paper
Venture investment activity covers many phases of financial stages. In spite of the increased attention to the venture capital process during the last three decades, misconceptions about the industry still exist. This paper examines annualized returns for different stages of financing in venture-backed public companies. The unique database includes current actively and inactively trading public companies. The data enable one to ascertain the relationship among companies’ annualized rates of return, share price at the Initial Public Offering (IPO) date, IPO size, current total shares, and the role of venture capital. Annualized returns are found to be positively affected by cumulative returns, IPO year, current price, and IPO size in dollars while being negatively influenced by IPO price. The paper refutes the myth that investors demand very high rates of return to compensate for the risks involved in financing ventures. Download Paper
This paper analyzes the utility maximization of a burglar who anticipates the revenue generated by his action along with the associated costs. The benefits are the value of the loot. Costs include the location of the home, the physical appearance, the demographic characteristics, and the security precautions present. When combined, they will either attract or detract criminal activity. A survey relating characteristics of Greenwich, Connecticut homes to burglary rates is used. The Logit model and the odds ratio integrate the above home characteristics to determine the likelihood of the home being victimized. The odds ratio calculates the probabilities of the home being victimized as a function of its characteristics. The results suggest the relative importance of each factor in contributing to the home becoming a target of burglary. The model can be used to predict the chances of homes being burgled depending on it specific attributes. Download Paper
The potential impact of continued economic growth on world energy markets could be substantial. Rapid growth projections into the next ten and twenty years suggested that the East Asian area (Korea, China, Hong Kong, Malaysia, Philippines, Thailand, Indonesia, and Singapore, where Japan is included with the OECD high-income countries) will be a major center of world GDP. Thus, the region’s burgeoning energy needs would make an important difference in the supply-demand balance and would raise world energy prices. The environmental implications for the rise in energy are evident. This paper analyzes the implications of the l997 East Asian crisis on the projections of energy used by this region. Estimates of the energy elasticities based on pooled cross section and time series are used to forecast energy and petroleum consumption and imports into the region under a variety of assumptions about the future economic outlook and policy. Download Paper
The objective of this paper is to assess the investment opportunities emerging in the newly developing stock markets of Eastern Europe. The Czech Republic, Hungary, and Poland, representative of the emerging stock markets of Eastern Europe, are examined from the perspective of a US investor who invests solely in the US markets. During the period November 24, 1994 to May 12, 1995, the most advantageous investment strategy is derived using optimization algorithms, comparing the optimal portfolio in the stock markets of a select group of Eastern European countries against the S&P 500 Index, representative of the US stock markets. Based on market volatility, sovereign risks, and foreign exchange the risks and rewards of investing in these countries are appraised. The results show that the risk-adjusted return, yielded from the optimal portfolio, exceeds or equals the return realizable from investing in stock markets with lesser degrees of risk. Download Paper
The objective of this paper is to examine the dynamic interrelations among major world stock markets through the use of artificial neural networks. The data was derived from daily stock market indices of the major world stock markets of Canada, France, Germany, Japan, United Kingdom (UK), the United States (US), and the world excluding US (World). Multilayer Perceptron models with logistic activation functions were better able to foresee the daily stock returns than the traditional forecasting models, in terms of lower mean squared errors. Furthermore, a multilayer perceptron with five units in the hidden layer seemed to predict more precisely the returns of stock indices than a neural network with two hidden elements. Hence, it is inferred that neural systems could be used as an alternative or supplemental method for predicting financial variables and thus justified the potential use of these model by practitioners. Download Paper
Investors making complementary investments typically do not have incentives to invest efficiently when they cannot contract with each other prior to their decisions because of the hold-up problem: when they bargain over the surplus generated by their investments, they will usually not obtain the full fruits of the investment. Intuitively, the hold-up problem should be ameliorated if, in the bargaining stage, each agent has alternatives to the partner he is bargaining with. We characterize the matching and division of surplus in finite economies for any initial investment decisions. We provide conditions on those decisions that guarantee that each agent will capture the change in the aggregate social surplus that results from any investment change he makes. We further show that for any given problem, there exists a bargaining rule by which pairs split their surplus that will support efficient investment choices in equilibrium. We also show, however, that over invest­ment or underinvestment can occur for natural bargaining rules. Download Paper
This paper shows the general reversibility of every perfect foresight equilibrium of an overlapping generations economy. It then shows and characterizes the existence of reversible sunspot equilibria in these economies as well, which seems to be at odds with our intuition about the irreversibility of a tree of events. Although the paper establishes also that such reversible stochastic equilibria constitute a negligible subset of all the equilibria of their class, their mere existence may be considered somewhat puzzling for this intuition. Download Paper
This paper establishes in a general way the existence of a connection between the stationary equilibria of an infinite horizon economy and the equilibria of a naturally related finite economy. More specifically, the connection is established first between the cycles of a stationary overlapping generations economy and the equilibria of a related finite economy with a cyclical structure. Then the connection is shown to hold also when extrinsic uncertainty (a sunspot) is introduced in the models. The connection holds in this case between a kind of sunspot equilibria called here sunspot cycles, and the correlated equilibria of the finite economy when there is asymmetric information about the extrinsic uncertainty. Incidentally, the sunspot cycles constitute a class of sunspot equilibria that are able to generate time series fluctuating in the recurrent but irregular way characteristic to some economic time series. Download Paper
We consider a dynamic general equilibrium asset pricing model with heterogeneous agents and asymmetric information. We show how agents' different methods of gathering information affect their chances of survival in the market depending upon the nature of the information and the level of noise in the economy. Download Paper
Economists typically analyze individuals' market behavior in isolation from their nonmarket decisions. While this research strategy has generally been successful, it can lead to systematic errors when agents' nonmarket behavior affects their market choices. In this paper we analyze how individuals' investment behavior changes as a result of nonmarket behavior. Specifically, we analyze a model in which individuals must decide how to al­ locate their initial endowment between two random investments, where the returns are perfectly correlated across individuals for the first investment but independent across individuals for the second. We consider an environment in which men and women match, with wealthier individuals more successful in matching. We show how individuals' concern about relative wealth can affect their investment decisions, and we provide conditions under which individuals bias their investments either toward or away from the investment with correlated returns. A modification of the model is used to explain why agents’ investments might exhibit a home country bias. Download Paper
Do investors making complementary investments face the correct incen­tives, especially when they cannot contract with each other prior to their de­cisions? We present a two-sided matching model in which buyers and sellers make investments prior to matching. Once matched, buyer and seller bar­ gain over the price, taking into account outside options. Efficient decisions can always be sustained in equilibrium. We characterize the inefficiencies that can arise in equilibrium, and show that equilibria will be constrained efficient. We also show that the degree of diversity in a large market has implications for the extent of any inefficiency. Download Paper
In an environment in which both buyers and sellers can undertake match specific investments, the presence of market competition for matches may solve hold-up and coordination problems generated by the absence of complete contingent contracts. In particular, this paper shows that when matching is assortative and sellers’ investments precede market competition then investments are constrained efficient. One equilibrium is efficient with efficient matches but also there can be equilibria with coordination failures. Different types of inefficiency arise when buyers undertake investment before market competition. These inefficiencies lead to buyers’ under-investments due to a hold-up problem but, when competition is at its peak, there is a unique equilibrium of the competition game with efficient matches — no coordination failures — and the aggregate hold-up inefficiency is small in a well defined sense independent of market size. Download Paper
In this paper we endogenize the number and characteristics of lobbies in a citizen-candidate model of representative democracy where citizens can lobby an elected policy-maker. We find that lobbying always matters. That is, lobbying always affects equilibrium policy outcomes. Moreover, only one policy outcome emerges in equilibrium. An “extremist” candidate is elected and implements a “centrist” policy that differs from the one most preferred by the median voter. These results are in contrast with the ones obtained in the context of a citizen-candidate model where lobbies are exogenous. Download Paper
According to the conventional view, in politics, just as in economic markets, competition between politicians is a force that pushes towards efficiency. We provide a model that challenges this view. In the model, candidates can promise to provide a public good or to engage in redistributive politics. We show that the more intense is competition (measured by an increase in the number of candidates) the greater the inefficiency. This is because the tendency to focus on policies that provide particularistic benefits increases with the number of candidates at the expense of policies that benefit the population at large. We also examine the impact of voters’ ideology, participation, and information on the efficiency of the electoral process, by allowing for heterogeneity in voters’ responsiveness to electoral promises. The larger the fraction of non-responsive voters, the less efficient the political process. This is because electoral competition focuses on swing voters, increasing the value of policies with targetable benefits. Download Paper
In this paper we critically examine the main workhorse model in asset pricing theory, the Lucas (1978) tree model (LT-Model), extended to include heterogeneous agents and multiple goods, and contrast it to the benchmark model in financial equilibrium theory, the real assets model (RA-Model). Households in the LT-Model trade goods together with claims to Lucas trees (exogenous stochastic dividend streams specified in terms of a particular good) and zero- net-supply real bonds, and are endowed with share portfolios. The RA-Model is quite similar to the LT-Model except that the only claims traded there are zero-net-supply assets paying out in terms of commodity bundles (real assets) and households’ endowments are in terms of commodity bundles as well. At the outset, one would expect the two models to deliver similar implications since the LT-Model can be transformed into a special case of the RA- Model. We demonstrate that this is simply not correct: results obtained in the context of the LT-Model can be strikingly different from those in the RA-Model. Indeed, specializing households’ preferences to be additively separable (over time) as well as log-linear, we show that for a large set of initial portfolios the LT-Model – even with potentially complete financial markets – admits a peculiar financial equilibrium (PFE) in which there is no trade on the bond market after the initial period, while the stock market is completely degenerate, in the sense that all stocks offer exactly the same investment opportunity – and yet, allocation is Pareto optimal. We then thoroughly investigate why the LT-Model is so much at variance with the RA-Model, and also completely characterize the properties of the set of PFE, which turn out to be the only kind of equilibria occurring in this model. We also find that when a PFE exists, either (i) it is unique, or (ii) there is a continuum of equilibria: in fact, every Pareto optimal allocation is supported as a PFE. Finally, we show that our results continue to hold true in the presence of various types of restrictions on transactions in financial markets. While our analysis is carried out in the framework of the traditional two-period Arrow-Debreu-McKenzie pure exchange model with uncertainty (encompassing, in particular, many types of contingent commodities), we show that similar results hold for the analogous continuous-time martingale model of asset pricing. Download Paper