Resolving inconsistencies in utility measurement under risk: Tests of generalizations of expected utility

This paper explores biases in the elicitation of utilities under risk and the contribution that generalizations of expected utility can make to the resolution of these biases. We used five methods to measure utilities under risk and found clear violations of expected utility. Of the theories studies, prospect theory was most consistent with our data. The main improvement of prospect theory over expected utility was in comparisons between a riskless and a risky prospect(riskless-risk methods). We observed no improvement over expected utility in comparisons between two risky prospects (risk-risk methods). An explanation why we found no improvement of prospect theory over expected utility in risk-risk methods may be that there was less overweighting of small probabilities in our study than has commonly been observed.

The biogeography of mitochondrial and nuclear discordance in animals.

Combining nuclear (nuDNA) and mitochondrial DNA (mtDNA) markers has improved the power of molecular data to test phylogenetic and phylogeographic hypotheses and has highlighted the limitations of studies using only mtDNA markers. In fact, in the past decade, many conflicting geographic patterns between mitochondrial and nuclear genetic markers have been identified (i.e. mito-nuclear discordance). Our goals in this synthesis are to: (i) review known cases of mito-nuclear discordance in animal systems, (ii) to summarize the biogeographic patterns in each instance and (iii) to identify common drivers of discordance in various groups. In total, we identified 126 cases in animal systems with strong evidence of discordance between the biogeographic patterns obtained from mitochondrial DNA and those observed in the nuclear genome. In most cases, these patterns are attributed to adaptive introgression of mtDNA, demographic disparities and sex-biased asymmetries, with some studies also implicating hybrid zone movement, human introductions and Wolbachia infection in insects. We also discuss situations where divergent mtDNA clades seem to have arisen in the absence of geographic isolation. For those cases where foreign mtDNA haplotypes are found deep within the range of a second taxon, data suggest that those mtDNA haplotypes are more likely to be at a high frequency and are commonly driven by sex-biased asymmetries and/or adaptive introgression. In addition, we discuss the problems with inferring the processes causing discordance from biogeographic patterns that are common in many studies. In many cases, authors presented more than one explanation for discordant patterns in a given system, which indicates that likely more data are required. Ideally, to resolve this issue, we see important future work shifting focus from documenting the prevalence of mito-nuclear discordance towards testing hypotheses regarding the drivers of discordance. Indeed, there is great potential for certain cases of mitochondrial introgression to become important natural systems within which to test the effect of different mitochondrial genotypes on whole-animal phenotypes.

Cashing by the hour: Why large law firms prefer hourly fees over contingent fees

Large law firms seem to prefer hourly fees over contingent fees. Thispaper provides a moral hazard explanation for this pattern of behavior.Contingent legal fees align the interests of the attorney with those ofthe client, but not necessarily with those of the partnership. We showthat the choice of hourly fees is a solution to an agency problem withmultiple principals, where the interests of one principal (law firm)collide with the interests of the other principal (client).

On the cultural transmission of corruption

We provide a cultural explanation to the phenomenon of corruption in the framework of an overlapping generations model with intergenerational transmissionof values. We show that the economy has two steady states with different levels of corruption. The driving force in the equilibrium selection process is the education effort exerted by parents which depends on the distribution of ethics in the population and on expectations about future policies. We propose some policy interventions which via parents' efforts have long-lasting effects on corruption and show the success of intensive education campaigns. Educating the young is a key element in reducing corruption successfully.

The vanishing procyclicality of labor productivity

We document three changes in postwar US macroeconomic dynamics: (i) theprocyclicality of labor productivity has vanished, (ii) the relative volatility of employment has risen, and (iii) the relative (and absolute) volatility of the real wagehas risen. We propose an explanation for all three changes that is based on a common source: a decline in labor market frictions. We develop a simple model withlabor market frictions, variable effort, and endogenous wage rigidities to illustratethe mechanisms underlying our explanation. We show that the reduction in frictionsmay also have contributed to the observed decline in output volatility.

Turbulence and unemployment in a job matching model

According to Ljungqvist and Sargent (1998), high European unemployment since the 1980s can be explained by a rise in economic turbulence, leading to greater numbers of unemployed workers with obsolete skills. These workers refuse new jobs due to high unemployment benefits. In this paper we reassess the turbulence-unemployment relationship using a matching model with endogenous job destruction. In our model, higher turbulence reduces the incentives of employed workers to leave their jobs. If turbulence has only a tiny effect on the skills of workers experiencing endogenous separation, then the results of Lungqvist and Sargent (1998, 2004) are reversed, and higher turbulence leads to a reduction in unemployment. Thus, changes in turbulence cannot provide an explanation for European unemployment that reconciles the incentives of both unemployed and employed workers.

Merger failures

This paper proposes an explanation as to why some mergers fail, based on the interactionbetween the pre- and post-merger processes. We argue that failure may stem from informationalasymmetries arising from the pre-merger period, and problems of cooperation andcoordination within recently merged firms. We show that a partner may optimally agree tomerge and abstain from putting forth any post-merger effort, counting on the other partnerto make the necessary efforts. If both follow the same course of action, the merger goesahead but fails. Our unique equilibrium allows us to make predictions on which mergers aremore likely to fail.

Convertibility, currency controls and the cost of capital in Western Europe, 1950-1999

For most of the post-war period, Europe s capital markets remained largely closed to international capital flows. Thispaper explores the costs of this policy. Using an event-study methodology, I examine the extent to which restrictions ofcurrent and capital account convertibility affected stock returns. The delayed introduction of full currency convertibilityincreased the cost of capital. Also, a string of measures designed to reduce capital mobility before the ultimate collapseof the Bretton Woods System had considerable negative effects. These findings offer an explanation for the mountingevidence suggesting that capital account liberalization facilitates growth.

Relying on the agent in charge of production for project evaluation

I study the optimal project choice when the principal relies on the agent in charge of production for project evaluation. The principal has to choose between a safe project generating a fixed revenue and a risky project generating an uncertain revenue. The agent has private information about the production cost under each project but also about the signal regarding the profitability of the risky project. If the signal favoring the adoption of the risky project is goods news to the agent, integrating production and project evaluation tasks does not generate any loss compared to the benchmark in which the principal herself receives the signal. By contrast, if it is bad news, task integration creates an endogenous reservation utility which is type-dependent and thereby generates countervailing incentives, which can make a bias toward either project optimal. Our results can offer an explanation for why good firms can go bad and a rationale for the separation of day-to-day operating decisions from long-term strategic decisions stressed by Williamson.

A century of global equity market correlations

In this paper, we use a unique long-run dataset of regulatory constraints on capital account openness to explain stock market correlations. Since stock returns themselves are highly volatile, any examination of what drives correlations needs to focus on long runs of data. This is particularly true since some of the short-term changes in co-movements appear to reverse themselves (Delroy Hunter 2005). We argue that changes in the co-movement of indices have not been random. Rather, they are mainly driven by greater freedom to move funds from one country to another. In related work, Geert Bekaert and Campbell Harvey (2000) show that equity correlations increase after liberalization of capital markets, using a number of case studies from emerging countries. We examine this pattern systematically for the last century, and find it to be most pronounced in the recent past. We compare the importance of capital account openness with one main alternative explanation, the growing synchronization of economic fundamentals. We conclude that greater openness has been the single most important cause of growing correlations during the last quarter of a century, though increasingly correlated economic fundamentals also matter. In the conclusion, we offer some thoughts on why the effects of greater openness appear to be so much stronger today than they were during the last era of globalization before 1914.

Social security and democracy

Many political economic theories use and emphasize the process of votingin their explanation of the growth of Social Security, governmentspending, and other public policies. But is there an empirical connectionbetween democracy and Social Security program size or design? Using somenew international data sets to produce both country-panel econometricestimates as well as case studies of South American and southern Europeancountries, we find that Social Security policy varies according toeconomic and demographic factors, but that very different politicalhistories can result in the same Social Security policy. We find littlepartial effect of democracy on the size of Social Security budgets, onhow those budgets are allocated, or how economic and demographic factorsaffect Social Security. If there is any observed difference, democraciesspend a little less of their GDP on Social Security, grow their budgetsa bit more slowly, and cap their payroll tax more often, than doeconomically and demographically similar nondemocracies. Democracies andnondemocracies are equally likely to have benefit formulas inducingretirement and, conditional on GDP per capita, equally likely to induceretirement with a retirement test vs. an earnings test.

Inequality over the business cycle: Estimating income risk using micro-data on consumption

We use CEX repeated cross-section data on consumption and income, to evaluate the nature of increased income inequality in the 1980s and 90s. We decompose unexpected changes in family income into transitory and permanent, and idiosyncratic and aggregate components, and estimate the contribution of each component to total inequality. The model we use is a linearized incomplete markets model, enriched to incorporate risk-sharing while maintaining tractability. Our estimates suggest that taking risk sharing into account is important for the model fit; that the increase in inequality in the 1980s was mainly permanent; and that inequality is driven almost entirely by idiosyncratic income risk. In addition we find no evidence for cyclical behavior of consumption risk, casting doubt on Constantinides and Duffie s (1995) explanation for the equity premium puzzle.

Financial development, financial fragility and growth

This paper studies the apparent contradiction between two strands of the literature on the effects of financial intermediation on economic activity. On the one hand, the empirical growth literature finds a positive effect of financial depth as measured by, for instance, private domestic credit and liquid liabilities (e.g., Levine, Loayza, and Beck 2000). On the other hand, the banking and currency crisis literature finds that monetary aggregates, such as domestic credit, are among the best predictors of crises and their related economic downturns (e.g., Kaminski and Reinhart 1999). The paper accounts for these contrasting effects based on the distinction between the short- and long-run impacts of financial intermediation. Working with a panel of cross-country and time-series observations, the paper estimates an encompassing model of short- and long-run effects using the Pooled Mean Group estimator developed by Pesaran, Shin, and Smith (1999). The conclusion from this analysis is that a positive long-run relationship between financial intermediation and output growth co-exists with a, mostly, negative short-run relationship. The paper further develops an explanation for these contrasting effects by relating them to recent theoretical models, by linking the estimated short-run effects to measures of financial fragility(namely, banking crises and financial volatility), and by jointly analyzing the effects of financial depth and fragility in classic panel growth regressions.

The persistence of inflation in OECD countries: A fractionally integrated approach

The statistical properties of inflation and, in particular, its degree of persistence and stability over time is a subject of intense debate and no consensus has been achieved yet. The goal of this paper is to analyze this controversy using a general approach, with the aim of providing a plausible explanation for the existing contradictory results. We consider the inflation rates of 21 OECD countries which are modelled as fractionally integrated (FI) processes. First, we show analytically that FI can appear in inflation rates after aggregating individual prices from firms that face different costs of adjusting their prices. Then, we provide robust empirical evidence supporting the FI hypothesis using both classical and Bayesian techniques. Next, we estimate impulse response functions and other scalar measures of persistence, achieving an accurate picture of this property and its variation across countries. It is shown that the application of some popular tools for measuring persistence, such as the sum of the AR coefficients, could lead to erroneous conclusions if fractional integration is present. Finally, we explore the existence of changes in inflation inertia using a novel approach. We conclude that the persistence of inflation is very high (although non-permanent) in most post-industrial countries and that it has remained basically unchanged over the last four decades.

Measuring intangibles' productivity. Empirical evidence from Spanish firms

As companies and shareholders begin to note the potential repercussions of intangible assets uponbusiness results, the inability of the traditional financial statement model to reflect these new waysof creating business value has become evident. Companies have widely adopted newmanagement tools, covering in this way the inability of the traditional financial statement model toreflect these new ways of creating business value.However, there are few prior studies measuring on a quantifiable manner the level of productivityunexplained in the financial statements. In this study, we measure the effect of intangible assets onproductivity using data from Spanish firms selected randomly by size and sector over a ten-yearperiod, from 1995 to 2004. Through a sample of more than 10,000 Spanish firms we analyse towhat extent labour productivity can be explained by physical capital deepening, by quantifiedintangible capital deepening and by firm s economic efficiency (or total factor productivity PTF).Our results confirm the hypothesis that PTF weigh has increased during the period studied,especially on those firms that have experienced a significant raise in quantified intangible capital,evidencing that there are some important complementary effects between capital investment andintangible resources in the explanation of productivity growth. These results have significantdifferences considering economic sector and firm s dimension.