UPDATED:
23 November, 2007
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Mechanism
Design with Interdependent Valuations: Surplus Extraction
(file size: 268K, last updated: 03/2006)
If valuations are interdependent and agents observe their own allocation payoffs, then two-stage revelation mechanisms expand the set of implementable decision functions. In a two-stage revelation mechanism agents report twice. In the first stage - before the allocation is decided - they report their private signals. In the second stage - after the allocation has been made, but before final transfers are decided - they report their payoffs from the allocation. Conditions are provided under which an uninformed seller can extract (or virtually extract) the full surplus from a sale to privately informed buyers, in spite of the buyers’ signals being independent random variables.
What
Will I Be When I Grow Up? An Analysis of Childhood Expectations and Career
Outcomes
(file size: 287K, last updated: 11/2004)
In this paper we utilise the British National Child Development Study to explore the determinants of children’s career expectations formed at the age of sixteen. We analyse how such career expectations impact upon human capital accumulation at the same age. We also analyse the extent of any divergence between childhood career expectations and the actual career outcomes experienced by the individuals at three distinct ages in adulthood (23, 33 and 42) as well as the impact of any such divergence on early- and mid-career wage growth. Our findings suggest that career expectations are an important determinant of human capital accumulation, which in turn is a key determinant of occupational status.
Re-examining
the Consumption-Wealth Relationship: The Role of Model Uncertainty
(file size: 276K, last updated: 02/2005)
This paper discusses the consumption-wealth relationship. Following the recent influential work of Lettau and Ludvigson [e.g. Lettau and Ludvigson (2001), (2004)], we use data on consumption, assets and labor income and a vector error correction framework. Key findings of their work are that consumption does respond to permanent changes in wealth in the expected manner, but that most changes in wealth are transitory and have no effect on consumption. We investigate the robustness of these results to model uncertainty and argue for the use of Bayesian model averaging. We find that there is model uncertainty with regards to the number of cointegrating vectors, the form of deterministic components, lag length and whether the cointegrating residuals affect consumption and income directly. Whether this uncertainty has important empirical implications depends on the researcher's attitude towards the economic theory used by Lettau and Ludvigson. If we work with their model, our findings are very similar to theirs. However, if we work with a broader set of models and let the data speak, we obtain somewhat different results. In the latter case, we find that the exact magnitude of the role of permanent shocks is hard to estimate precisely. Thus, although some support exists for the view that their role is small, we cannot rule out the possibility that they have a substantive role to play.
Improper
priors with well defined Bayes Factors
(file size: 369K, last updated: 03/2005)
While some improper priors have attractive properties, it is generally claimed that Bartlett’s paradox implies that using improper priors for the parameters in alternative models results in Bayes factors that are not well defined, thus preventing model comparison in this case. In this paper we demonstrate, using well understood principles underlying what is already common practice, that this latter result is not generally true and so expand the class of priors that may be used for computing posterior odds to two classes of improper priors: the shrink age prior; and a prior based upon a nesting argument. Using a new representation of the issue of undefined Bayes factors, we develop classes of improper priors from which well defined Bayes factors result. However, as the use of such priors is not free of problems, we include discussion on the issues with using such priors for model comparison.
Household
Debt and Financial Assets: Evidence from Great Britain, Germany and the
United States
(file size: 313K, last updated: 03/2005)
We explore the determinants of debt and financial asset accumulation at the household level using survey data for Great Britain, Germany and the United States (US). Given that debt and assets are both components of a household’s financial portfolio, we explore the degree of inter-dependence between households’ assets and liabilities by jointly modelling these two aspects of the portfolio. Indeed, our empirical findings for both countries support a high degree of inter-dependence between debt and asset holding. Furthermore, the nature of this inter-dependence varies across income ranges and age groups with the weakest correlation between financial assets and debt being found for the lowest income groups in Great Britain, suggesting that such groups may be particularly vulnerable to adverse financial shocks. Evidence supporting inter-dependence between assets and debt no longer remains, however, once we focus on debtors which suggests that households in debt may potentially face difficulties following adverse changes in their financial situation.
How
Do Alternative Minimum Wage Variables Compare?
(file size: 215K, last updated: 03/2005)
Several minimum wage variables have been suggested in the literature. Such a variety of variables makes it difficult to compare the associated estimates across studies. One problem is that these estimates are not always calibrated to represent the effect of a 10% increase in the minimum wage. Another problem is that these estimates measure the effect of the minimum wage on the employment of different groups of workers. In this paper we critically compare employment effect estimates using five minimum wage variables common in the literature: real minimum wage, “Kaitz index”, “fraction affected”, “fraction at” and “ fraction below” the minimum wage. Our principal finding is that the sign of this effect is robust across minimum wage variables, but its magnitude and significance are sensitive to the minimum wage variable used.
“Ethical
Tourism” or Self-Preservation? An Empirical Analysis of the Effect
of Political Violence on Tourism in Egypt in the 1990s
(file size: 224K, last updated: 03/2005)
This paper uses a new database of political violence in Egypt to study the effects of political violence on the monthly arrival of tourists from the EU and the US in Egypt in the 1990s. We use time series analysis to study the impact of different aspects of political violence and counter-violence. We find that both US and EU tourists respond negatively to attacks on tourists, but do not appear to be influenced by casualties arising in confrontations between domestic groups. However, European tourists are sensitive to the counter-violence measures implemented by the Egyptian government. There is also evidence of tourism in Egypt being affected by the Israeli / Palestinian conflict, with arrivals of US tourists into Egypt rising when fatalities in Israel increase, while European tourists reduce their demand for Egyptian holidays.
Openness,
Institutions and Financial Development
(file size: , last updated: 04/2005)
This paper is no longer available. It has been replaced by
07/5 - Badi H. Baltagi, Panicos O. Demetriades, Siong Hook Law
Financial Development, Openness and Institutions: Evidence from Panel Data
Mortgages
and Financial Expectations: A Household Level Analysis
(file size: 439K, last updated: 12/2006)
We contribute to the literature on household mortgage debt by exploring one particular influence on mortgage debt at the household level, namely the financial expectations of the individuals within the household. Our theoretical model predicts a positive association between the quantity of mortgage debt and optimistic financial expectations. Our empirical findings based on household level data provide convincing support for our theoretical priors in that optimistic financial expectations are positively associated with the level of outstanding mortgage debt.
The
Impact of Labour Turnover: Theory and Evidence from UK Micro-Data
(file size: 309K, last updated: 05/2007)
We analyse the impact of labour turnover on profits. We extend the efficiency wage model of Salop (1979) by separating incumbent and newly hired workers in the production function. We show that an exogenous increase in the turnover rate can increase profits, but only where firms do not choose the wage. This effect of turnover varies across firms as it depends on turnover costs, the substitutability of incumbents and new hires and other factors. We test our model on UK cross-sectional establishment-level data. We find that our predictions are consistent with the data.
"An
Eye for an Eye, a Tooth for a Tooth." A Study of Political Violence
and Counter-insurgency in Egypt
(file size: 210K, last updated: 05/2005)
This paper analyses a newly collected time-series database measuring the dimensions of violent political conflict in Egypt. Attention is focused on the interaction between politically motivated attacks by Islamists and the counter-insurgency measures used by the Egyptian government. The intensity of security force activities responds immediately to all kinds of Islamist violence, regardless of the target of the attack. However, there are significant asymmetries in the way that the different forms of Islamist violence respond to the different security force activities.
The
Political Economy of Financial Liberalisation
(file size: 560K, last updated: 10/2005)
Political economy theories of financial development argue that in countries where a narrow elite controls political decisions, financial development may be deliberately obstructed to deny access to finance to potential competitors. This paper empirically examines whether the level of liberalisation of the banking system, the stock market and capital account depend on regime characteristics, using panel data from 26 countries from 1973 – 1999. Our results show that it is predominantly fully democratic regimes that have liberalised financial systems. Countries that are not fully democratic have a lower probability of having liberal banking systems and capital accounts and this probability decreases with increasing democratisation. This suggests that the attractiveness of using financial levers to allocate funds in the economy increases with the amount of competition the government faces, although a fully competitive electoral system creates incentives to relinquish financial control.
Efficient Posterior Simulation for Cointegrated Models with Priors On the Cointegration Space
(file size: 191K, last updated: 04/2006)
A message coming out of the recent Bayesian literature on cointegration is that it is important to elicit a prior on the space spanned by the cointegrating vectors (as opposed to a particular identified choice for these vectors). In this note, we discuss a sensible way of eliciting such a prior. Furthermore, we develop a collapsed Gibbs sampling algorithm to carry out efficient posterior simulation in cointegration models. The computational advantages of our algorithm are most pronounced with our model, since the form of our prior precludes simple posterior simulation using conventional methods (e.g. a Gibbs sampler involves non-standard posterior conditionals). However, the theory we draw upon implies our algorithm will be more efficient even than the posterior simulation methods which are used with identified versions of cointegration models.
Bayesian Inference in Cointegrated I (2) Systems: a Generalisation of the Triangular Model
(file size: 342K, last updated: 07/2005)
This paper generalises the cointegrating model of Phillips (1991) to allow for I (0) , I (1) and I (2) processes. The model has a simple form that permits a wider range of I (2) processes than are usually considered, including a more flexible form of polynomial cointegration. Further, the specification relaxes restrictions identified by Phillips (1991) on the I (1) and I (2) cointegrating vectors and restrictions on how the stochastic trends enter the system. To date there has been little work on Bayesian I (2) analysis and so this paper attempts to address this gap in the literature. A method of Bayesian inference in potentially I (2) processes is presented with application to Australian money demand using a Jeffreys prior and a shrinkage prior.
Minimum Wage Effects on Wages, Employment and Prices: Implications for Poverty Alleviation in Brazil
(file size: 213K, last updated: 08/2005)
This paper presents new evidence on the effects of the minimum wage using Brazilian monthly household and firm panel data between 1982 and 2000. By examining the effects on wages, employment and prices together we are able to provide an explanation for the small employment effects prevalent in the literature. Our principal finding is that increasing the minimum wage raises wages and prices with small adverse employment effects. This suggests a general wage-price inflationary spiral, where persistent inflation offsets some of the wage gains. The main policy implication deriving from these results is that the potential of the minimum wage to help the poor is bigger under low inflation. Under high inflation, the resulting wage-price spiral makes the minimum wage increase — as well as its antipoverty policy potential — short lived. In this case, the wage effects are volatile and the permanent scars are lower employment and higher inflation in Brazil.
Corruption And The Provision Of Public Output In A Hierarchical Asymmetric Information Relationship
(file size: 808K, last updated: 08/2005)
This paper develops a hierarchical principal-agent model to explore the influence of corruption, bribery, and politically provided oversight of production on the efficiency and level of output of some publicly provided good. Under full information, an honest politician acheives the first best while a dishonest politician creates shortages and bribes. Under asymmetric information, however, an honest politician might create more shortages relative to a dishonest one, although, the latter creates greater bribes. Furthermore, the contracted output can be greater or smaller relative to that produced by an unregulated private monopolist. The model identifies a tradeoff between bribery and allocative efficiency. This helps to reconcile some conflicting results on the implications of corruption for the size of the public sector and provides new results on the circumstances under which an improvement in the auditing technology is beneficial. Relative to the static case, in the dynamic renegotiation-proof equilibrium, shortages fall but bribes can increase or decrease, raising important issues of the choice between long-term and short-term contracts.
Alice Through the Looking Glass: Strategic Monetary and Fiscal Policy Interaction in a Liquidity Trap
(file size: 422K, last updated: 08/2006)
The recent experience with low inflation, and the experience of several economies has reopened interest in the liquidity trap; which occurs when the nominal interest rate reaches its zero lower bound. To reduce the real interest rate, and to stimulate the economy, the modern literature highlights the role of high inflationary expectations. Using the Dixit-Lambertini (2003) framework of strategic policy interaction, we find that the optimal institutional response to the possibility of a liquidity trap has two main components. First, an optimal inflation target given to the Central Bank. Second, the Treasury, who retains control over fiscal policy and acts as leader, is given optimal output and inflation targets. This keeps inflationary expectations sufficiently high and achieves the optimal rational expectations pre-commitment solution. Simulations show that this arrangement is (1) optimal even when the Treasury has no inflation target but follow’s the optimal output target and (2) ‘near optimal’ even when the Treasury follows its own agenda through a suboptimal output target but is willing to follow an optimal inflation target. Finally, if monetary policy is delegated to an independent central bank with an optimal inflation target, but the Treasury retains discretion over fiscal policy, then the outcome can be a very poor one.
A Note On The Loewenstein-Prelec Theory Of Intertemporal Choice
(file size: 578K, last updated: 08/2005)
In one of the major contributions to behavioral economics, Loewenstein and Prelec (1992) set the foundations for the behavioral approach to decision making over time. We correct a number of errors in Loewenstein and Prelec (1992). Furthermore, we provide a correct, more direct and simpler derivation of their generalized hyperbolic discounting formula that has formed the basis of much recent work on temporal choice.
Insurance and Probability Weighting Functions
(file size: 317K, last updated: 09/2006)
Evidence shows that (i) people overweight low probabilities and underweight high probabilities, but (ii) ignore events of extremely low probability and treat extremely high probability events as certain. Decision models, such as rank dependent utility (RDU) and cumulative prospect theory (CP), use probability weighting functions. Existing probability weighting functions incorporate (i) but not (ii). Our contribution is threefold. First, we show that this would lead people, even in the presence of fixed costs and actuarially unfair premiums, to insure fully against losses of sufficiently low probability. This is contrary to the evidence. Second, we introduce a new class of probability weighting functions, which we call higher order Prelec probability weighting functions, that incorporate (i) and (ii). Third, we show that if RDU or CP are combined with our new probability weighting function, then a decision maker will not buy insurance against a loss of sufficiently low probability; in agreement with the evidence. We also show that our weighting function solves the St. Petersburg paradox that reemerges under RDU and CP.
A simple derivation of Prelec’s probability weighting function
(file size: 581K, last updated: 08/2005)
Since Kahneman and Tversky (1979), it has been generally recognized that decision makers overweight low probabilities and underweight high probabilities. Of the several weighting functions that have been proposed, that of Prelec (1998) has the attractions that it is parsimonious, consistent with much of the available empirical evidence and has an axiomatic foundation. Luce (2001) provided a simpler derivation based on reduction invariance, rather than compound invariance of Prelec (1998). This note gives a simpler form of reduction invariance, which we call power invariance. A more direct derivation of Prelec’s function is given, achieving a further simplification.
Coordination Failures, Philanthropy, and Public Policy
(file size: 742K, last updated: 08/2005)
We focus on an “equilibrium analysis” of coordination problems in giving that lead to multiple equilibria; the notion of strategic complements and substitutes turns out to be useful in this regard. Some societies can get stuck at a low level of giving while others might, by accident or policy, be able to coordinate on a higher level of giving. Ceteris-paribus, this furnishes one plausible reason for heterogeneity in philanthropy. We give conditions under which tax exemptions to private giving can have perverse effects by reducing equilibrium private giving. Direct government grants to charity, possibly temporary, can enable an economy stuck at an equilibrium with a low level of giving to attain an equilibrium with a high level of giving. Therefore, direct government grants can crowd-in private giving to charity. The paper contributes to the economics of philanthropy as well as to an understanding of the role of public policy in the face of private coordination failures.
Non-Linearities, Large Forecasters And Evidential Reasoning Under Rational Expectations
(file size: 702K, last updated: 08/2005)
Rational expectations is typically taken to mean that, conditional on the information set and the relevant economic theory, the expectation formed by an economic agent should be equal to its mathematical expectation. This is correct only when actual inflation is “linear” in the aggregate inflationary expectation or if it is non-linear then forecasters are “small” and use “causal reasoning”. We show that if actual inflation is non-linear in expected inflation and (1) there are “large” forecasters, or, (2) small/ large forecasters who use “evidential reasoning”, then the optimal forecast does not equal the mathematical expectation of the variable being forecast. We also show that when actual inflation is non-linear in aggregate inflation there might be no solution if one identifies rational expectations with equating the expectations to the mathematical average, while there is a solution using the “correct” forecasting rule under rational expectations. Furthermore, results suggest that published forecasts of inflation may be systematically different from the statistical averages of actual inflation and output, on average, need not equal the natural rate. The paper has fundamental implications for macroeconomic forecasting and policy, testing the assumptions and implications of market efficiency and for rational expectations in general.
Why Do People Pay Taxes? Prospect Theory Versus Expected Utility Theory
(file size: 382K, last updated: 08/2006)
Tax evasion analysis is typically based on an expected utility theory (EUT) framework. However, this leads to several qualitative and quantitative puzzles. Given actual probabilities of audit and penalty rates the return on evasion ranges from 91-98 percent. So why don’t most of us evade? Furthermore, an EUT based analysis predicts that we should evade less as the tax rate increases (Yitzhaki puzzle). Intuition and the bulk of the evidence do not support this result. This paper analyzes tax evasion using, instead, Kahneman and Tversky’s cumulative prospect theory. Under prospect theory we show that (1) the calibration results predict empirically plausible magnitudes of tax evasion despite low audit probabilities and penalty rates, and (2) the Yitzhaki puzzle is easily explained. Thus, our paper argues that not only does prospect theory provide a satisfactory explanation of tax evasion, it also argues that the phenomenon of tax evasion provides independent confirmation of prospect theory.
Optimal Distribution Of Powers In A Federation: A Simple, Unified Framework
(file size:707K, last updated: 08/2005)
In a federation with n ≥ 2 regions the relative optimality of six regimes- autarky, centralization, unregulated devolution, regulated devolution, direct democracy, and revenue maximising leviathan, is examined. Public policy consists of redistribution and regional public good provision. Regional incomes are uncertain and correlated while estimates of the usefulness of regional public goods are uncertain; the federal government’s estimates are noisier relative to those of regional governments. The optimality of each regime is influenced by four margins- regional insurance, coarseness of federal information, internalisation of spillovers and ‘raiding the commons’. Regulated devolution is the only regime that is capable of producing the constrained first best level of public goods. Federal insurance under the two regimes of direct democracy and a federal leviathan, can be inadequate relative to that under a utilitarian federal government. An increase in the number of regions has important implications for insurance and raiding the commons. The median region’s choice of redistribution under direct democracy is influenced in important ways by the distribution of regional uncertainties. The paper synthesises a significant proportion of the existing literature in a single model and also provides several new results.
A Simple Model of Optimal Tax Systems: Taxation, Measurement and Uncertainty
(file size: 675K, last updated: 08/2005)
The neglect of administrative issues is a serious limitation of optimal tax theory, with implications for its practical applicability. Under uncertainty, the problems for optimal tax theory are compounded when the full set of tax instruments is neglected. These twin issues are addressed in this paper, by focussing on a fundamental implication of administrative problems, namely, that the tax bases are measured with some error. Consumption taxes can perform the ‘social insurance role of taxation’; a role previously ascribed only to income taxes. A combination of income and consumption taxes can hedge income and measurement-error risks better, relative to the imposition of these taxes alone. The optimal taxes are decreasing in the imprecision with which the corresponding tax base is measured. The taxpayer engages in precautionary savings, in response to uncertainty arising on account of income and measurement problems. Differential commodity taxes, tailored to the measurability characteristics of the different tax bases, dominate uniform commodity taxes. Furthermore, the paper provides a simple, tractable framework for optimal tax theorists interested in diverse kinds of uncertain situations.
Sequential vs. Single-Round Uniform-Price Auctions
(file size: 258K, last updated: 04/2007)
We study sequential and single-round uniform-price auctions with affiliated values. We derive symmetric equilibrium for the auction in which k1 objects are sold in the first round and k2 in the second round, with and without revelation of the first-round winning bids. We demonstrate that auctioning objects in sequence generates a lowballing effect that reduces the first-round price. Total revenue is greater in a single-round, uniform auction for k = k1 + k2 objects than in a sequential uniform auction with no bid announcement. When the first-round winning bids are announced, we also identify a positive informational effect on the second-round price. Total expected revenue in a sequential uniform auction with winning-bids announcement may be greater or smaller than in a single-round uniform auction, depending on the model’s parameters.
Firm Turnover, Restructuring and Labour Productivity in Transition: The Case of Poland
(file size: 140K, last updated: 10/2005)
This paper explores the impact of turnover and restructuring on labour productivity in the Polish economy over the period 1988-1993. Changes in aggregate productivity are decomposed into elements corresponding to productivity growth among survivors, market share growth by survivors and the contributions of entering and exiting firms. The traditional entry and exit effects begin to work as transition to a market economy progresses. However, initial productivity improvements are due to changes to market shares of the existing firms following the break-up of large enterprises. Regression analysis shows that changes in the firm-level productivity are affected by restructuring and a more competitive economic environment.
Poverty and Fertility in Less Developed Countries: A Comparative Analysis
(file size: 306K, last updated: 11/2005)
Poverty and fertility are two important and closely related aspects of welfare. In this paper we use unique longitudinal data sources to study the relationship between poverty and fertility at household level in Albania, Ethiopia, Indonesia and Vietnam. These countries differ greatly in their history, average income, social structure, economic institutions and demographic features. We find that there is a substantial difference in the relative importance of the determinants of poverty dynamics and fertility; the persistence of high levels of fertility and poverty in Ethiopia is driven by lack of economic growth and poor access to family planning; education and health provision are crucial elements in reducing poverty and fertility, as is clear from Vietnam, Indonesia and Albania.
Skill-biased Technical Change and the Relative Pay and Employment of Men and Women in the UK Economy 1971 – 1991
(file size: 413K, last updated: 11/2005)
This paper presents quantitative estimates of the effects of technological change in industries and services on skill composition in the United Kingdom for four skill groups, for men and women separately for the period 1971 – 1991. The paper separates the effects of relative wage change, biased technological change and changes in sectoral composition and estimates the effect of biased technological change on relative pay.
The Technological Bias Against Production Workers in United States Manufacturing 1949 – 1996
(file size: 109K, last updated: 11/2005)
This paper presents quantitative estimates of the effects of technological change on the composition of production and non-production workers in manufacturing in the United States for the period 1950 – 1995. The paper separates the effects of relative wage change, biased technological change and changes in sectoral composition and estimates the effect of upward pressure on relative pay exerted by biased technological change.
The Long Run Bias Against Manual Workers in British Manufacturing 1920 – 1995
(file size: 323K, last updated: 11/2005)
This paper presents quantitative estimates of the effects of technological change on the composition of manual and non-manual employment in manufacturing in the United Kingdom for the period 1921 – 1995. The paper separates the effects of relative wage change, biased technological change and changes in sectoral composition and calculates the upward pressure on relative pay exerted by biased technological change.