Information revelation and market incompleteness

\documentstyle[portada,11pt]{article}This paper shows that the presence of private information in aneconomy can be a source of market incompleteness even when it is feasibleto issue a set of securities that completely eliminates the informationalasymmetries in equilibrium. We analyze a simple security design model in which avolume maximizing futures exchange chooses not only the characteristics ofeach individual contract but also the number of contracts. Agents have rationalexpectations and differ in information, endowments and, possibly, attitudestoward risk. The emergence of complete or incomplete markets in equilibriumdepends on whether the {\it adverse selection effect} is stronger or weakerthan the {\it Hirshleifer effect}, as new securitiesare issued and prices reveal more information. When the Hirshleifer effectdominates, the exchange chooses an incomplete set of financial contracts, andthe equilibrium price is partially revealing.

Do market conditions affect preferences? Evidence from experimental markets with excess supply and excess demand

We study whether people's preferences in an unbalanced market are affected by whether they are on the excess supply side or the excess demand side of the market. Our analysis is based on the comparison of behavior between two types of experimental gift exchange markets, which vary only with respect to whether first or second movers are on the long side of the market. The direction of market imbalance could influence subjects' motivation, as second movers, workers, might react differently to favorable actions by first movers, firms, in the two cases. Our data show strong deviations from the standard game-theoretic prediction. However, we only find secondary treatment effects. First movers are not more generous when they are in excess supply and second movers do not respond less favorably when they are in excess demand. Competition has only minor psychological effects in our data.

How well do individuals predict the selling prices of their homes?

Self-reported home values are widely used as a measure of housing wealth by researchers employing a variety of data sets and studying a number of different individual and household level decisions. The accuracy of this measure is an open empirical question, and requires some type of market assessment of the values reported. In this research, we study the predictive power of self-reported housing wealth when estimating sales prices utilizing the Health and Retirement Study. We find that homeowners, on average, overestimate the value of their properties by between 5% and 10%. More importantly, we are the first to document a strong correlation between accuracy and the economic conditions at the time of the purchase of the property (measured by the prevalent interest rate, the growth of household income, and the growth of median housing prices). While most individuals overestimate the value of their properties, those who bought during more difficult economic times tend to be more accurate, and in some cases even underestimate the value of their house. These results establish a surprisingly strong, likely permanent, and in many cases long-lived, effect of the initial conditions surrounding the purchases of properties, on how individuals value them. This cyclicality of the overestimation of house prices can provide some explanations for the difficulties currently faced by many homeowners, who were expecting large appreciations in home value to rescue them in case of increases in interest rates which could jeopardize their ability to live up to their financial commitments.

Conflicts of interest, information provision and competition in banking

In some markets, such as the market for drugs or for financial services, sellers have better information than buyersregarding the matching between the buyer's needs and the good's actual characteristics. Depending on the market structure,this may lead to conflicts of interest and/or the underprovision of information by the seller. This paper studies this issuein the market for financial services. The analysis presents a new model of competition between banks, as banks' pricecompetition influences the ensuing incentives for truthful information revelation. We compare two different firm structures,specialized banking, where financial institutions provide a unique financial product, and one-stop banking, where a financialinstitution is able to provide several financial products which are horizontally differentiated. We show first that, althoughconflicts of interest may prevent information disclosure under monopoly, competition forces full information provision forsufficiently high reputation costs. Second, in the presence of market power, one-stop banks will use information strategicallyto increase product differentiation and therefore will always provide reliable information and charge higher rices thanspecialized banks, thus providing a new justification for the creation of one-stop banks. Finally, we show that, ifindependent financial advisers are able to provide reliable information, this increases product differentiation and thereforemarket power, so that it is in the interest of financial intermediaries to promote external independent financial advice.

The provision on non-audit services by auditors: Let the market evolve and decide

The provision of non-audit services by auditors to their auditclients reduces total costs, increases technical competence and motivates more intense competition. Furthermore, theseservices do not necessarily damage auditor independence nor the quality of non-audit services. This assessment leads to recommending that legislative policy should aim at facilitating the development and use of the safeguardsprovided by the free action of market forces. Regulation should thus aim to enable the parties-audit firms, self-regulatory bodies and audit clients-to discover through competitive market interaction both the most efficient mix of services and the corresponding quality safeguards, adjusting for the costs and benefits of each possibility. Particular emphasis is placed on the role played by fee income diversification and the enhancement, through disclosurerules, of market incentives to diversify.

R&D in the pharmaceutical industry: A world of small innovations

It is commonly argued that in recent years pharmaceutical companies have directed theirR&D towards small improvements of existing compounds instead of more risky drastic innovations. In this paper we show that the proliferation of these small innovations is likely to be linked to the lack of market sensitivity of a part of the demand to changes in prices. Compared to their social contribution, small innovations are relatively more profitable than large ones because they are targeted to the smaller but more inelastic part of the demand. We also study the effect of regulatory instruments such as price ceilings, copayments and reference prices and extend the analysis to competition in research.

Audit quality: Attributes, private safeguards and the role of regulation

This article examines the private mechanisms used to safeguard quality in auditing, with a view to defining rules capable of facilitating the performance of market forces. An outline is given of a general theory of private quality assurance in auditing, based on the use of quasi-rents to self-enforce quality dimensions. Particular attention is paid to the role of fee income diversification as the key ingredient of private incentives for audit quality. The role of public regulation is then situated in the context defined by the presence of these safeguard mechanisms. This helps in defining the content of rules and the function of regulatory bodies in facilitating and strengthening the protective operation of the market. By making sense of the interaction between regulation, quality attributes and private safeguards, the analysis helps to evaluate the relative merits of different regulatory options.

A finite-population revenue management model and a risk-ratio procedure for the joint estimation of population size and parameters

Many dynamic revenue management models divide the sale period into a finite number of periods T and assume, invoking a fine-enough grid of time, that each period sees at most one booking request. These Poisson-type assumptions restrict the variability of the demand in the model, but researchers and practitioners were willing to overlook this for the benefit of tractability of the models. In this paper, we criticize this model from another angle. Estimating the discrete finite-period model poses problems of indeterminacy and non-robustness: Arbitrarily fixing T leads to arbitrary control values and on the other hand estimating T from data adds an additional layer of indeterminacy. To counter this, we first propose an alternate finite-population model that avoids this problem of fixing T and allows a wider range of demand distributions, while retaining the useful marginal-value properties of the finite-period model. The finite-population model still requires jointly estimating market size and the parameters of the customer purchase model without observing no-purchases. Estimation of market-size when no-purchases are unobservable has rarely been attempted in the marketing or revenue management literature. Indeed, we point out that it is akin to the classical statistical problem of estimating the parameters of a binomial distribution with unknown population size and success probability, and hence likely to be challenging. However, when the purchase probabilities are given by a functional form such as a multinomial-logit model, we propose an estimation heuristic that exploits the specification of the functional form, the variety of the offer sets in a typical RM setting, and qualitative knowledge of arrival rates. Finally we perform simulations to show that the estimator is very promising in obtaining unbiased estimates of population size and the model parameters.

Productivity growth and the exchange rate regime: The role of financial development

This paper offers empirical evidence that a country's choice of exchange rate regime can have a signifficant impact on its medium-term rate of productivity growth. Moreover, the impact depends critically on the country's level of financial development, its degree of market regulation, and its distance from the global technology frontier. We illustrate how each of these channels may operate in a simple stylized growth model in which real exchange rate uncertainty exacerbates the negative investment e¤ects of domestic credit market constraints. The empirical analysis is based on an 83 country data set spanning the years 1960-2000. Our approach delivers results that are in striking contrast to the vast existing empirical exchange rate literature, which largely finds the effects of exchange rate volatility on real activity to be relatively small and insignificant.

Spatial Polarization of the Ecological Footprint distribution

The international allocation of natural resources is determined, not by any ethical or ecological criteria, but by the dominance of market mechanisms. From a core-periphery perspective, this allocation may even be driven by historically determined structural patterns, with a core group of countries whose consumption appropriates most available natural resources, and another group, having low natural resource consumption, which plays a peripheral role. This article consists of an empirical distributional analysis of natural resource consumption (as measured by Ecological Footprints) whose purpose is to assess the extent to which the distribution of consumption responds to polarization (as opposed to mere inequality). To assess this, we estimate and decompose different polarization indices for a balanced sample of 119 countries over the period 1961 to 2007. Our results points toward a polarized distribution which is consistent with a core-periphery framework.

Spatial polarization of the ecological footprint distribution

The international allocation of natural resources is determined, not by any ethical or ecological criteria, but by the dominance of market mechanisms. From a core-periphery perspective, this allocation may even be driven by historically determined structural patterns, with a core group of countries whose consumption appropriates most available natural resources, and another group, having low natural resource consumption, which plays a peripheral role. This article consists of an empirical distributional analysis of natural resource consumption (as measured by Ecological Footprints) whose purpose is to assess the extent to which the distribution of consumption responds to polarization (as opposed to mere inequality). To assess this, we estimate and decompose different polarization indices for a balanced sample of 119 countries over the period 1961 to 2007. Our results points toward a polarized distribution which is consistent with a core-periphery framework. Keywords: Polarization, Core-Periphery, Ecological Footprint

Evidence on the role of ownership structure on firms' innovative performance

Based on the Knowledge Production Function framework given by Griliches -1979-, we slightly modify it so that the innovative output depends upon a set of factors related to the firm internal characteristics and are influenced by the environment. Specifically, regarding the firm internal determinants the effect of the concentration of the ownership, the composition of the boards of directors and the effect of the nature of the ownership (foreign and public) are analyzed. Additionally, in order to capture the determinants of the environment in which the firm operates other variables concerning the internationalization of market, the agglomeration economies and the regional knowledge externalities are also considered. In order to assess the impact of these determinants on the number of patents and models of use awarded by the firm, the discreteness of the latter variable has to be taken into account. We apply Poisson and Negative Binomial models for a more comprehensive evaluation of the hypothesis in a panel of Spanish manufacturing firms. The results show patenting activity is positively favoured by being located in an environment with a high innovative activity, due to the existence of knowledge spillovers and agglomeration economies.

Trade disclosure and price dispersion

This paper determines the effects of post-trade opaqueness on market performance. We find that the degree of market transparency has important effects on market equilibria. In particular, we show that dealers operating in a transparent structure set regret-free prices at each period making zero expected profits in each of the two trading rounds, whereas in the opaque market dealers invest in acquiring information at the beginning of the trading day. Moreover, we obtain that if there is no trading activity in the first period, then market makers only change their quotes in the opaque market. Additionally, we show that trade disclosure increases the informational efficiency of transaction prices and reduces volatility. Finally, concerning welfare of market participants, we obtain ambiguous results. Keywords: Market microstructure, Post-trade transparency, Price experimentation, Price dispersion.

Countervailing power? Collusion in markets with decentralized trade

We consider the collective incentives of buyers and sellers to form cartels in markets where trade is realized through decentralized pairwise bargaining. Cartels are coalitions of buyers or sellers that limit market participation and compensate inactive members for abstaining from trade. In a stable market outcome, cartels set Nash equilibrium quantities and cartel memberships are immune to defections. We prove that the set of stable market outcomes is non-empty and we provide its full characterization. Stable market outcomes are of two types: (i) at least one cartel actively restrains trade and the levels of market participation are balanced, or (ii) only one cartel, eventually the cartel that forms on the long side of the market, is active and it reduces trade slightly below the opponent's.

Investor protection, risk sharing and inequality

This paper studies the relationship between investor protection, financial risk sharing and income inequality. In the presence of market frictions, better protection makes investors more willing to take on entrepreneurial risk while lending to firms. This implies lower cost of external finance and better risk sharing between financiers and entrepreneurs. Investor protection, by boosting the market for risk sharing plays the twofold role of encouraging agents to undertake risky enterprises and providing them with insurance. By increasing the number of risky projects, it raises income inequality. By extending insurance to more agents, it reduces it. As a result, the relationship between the size of the market for risk sharing and income inequality is hump-shaped. Empirical evidence from a cross-section of sixty-eight countries, and a panel of fifty countries over the period 1976-2000, supports the predictions of the model.