HIER 2002 Abstracts

1943. Rafael La Porta, Florencio Lopez-de-Silanes, Cristian Pop-Eleches and Andrei Shleifer
The Guarantees of Freedom
Abstract | Paper
Hayek (1960) distinguishes the institutions of Engli­sh freedom, which guarantee the independence of judges from political interference in the administration of justice, from those of American freedom, which allow judges to restrain law-making powers of the sovereign through constitutional review. We create a data base of constitutional rules in 71 countries that reflect these institutions of English and American freedom, and ask whether these rules predict economic and political freedom in a cross-section of countries. We find that the English institutions of judicial independence are strong predictors of economic freedom and weaker predictors of political freedom. The American institutions of checks and balances are strong predictors of political but not of economic freedom. Judicial independence explains half of the positive effect of common law legal origin on measures of economic freedom.

1944.Mike Burkart, Fausto Panunzi, and Andrei Shleifer
Family Firms
Abstract | Paper
We present a model of succession in a firm controlled and managed by its founder. The founder decides between hiring a professional manager or leaving management to his heir, as well as on how much, if any, of the shares to float on the stock exchange. We assume that a professional is a better manager than the heir, and describe how the founder’s decision is shaped by the legal environment. Specifically, we show that, in legal regimes that successfully limit the expropriation of minority shareholders, the widely held professionally managed corporation emerges as the equilibrium outcome. In legal regimes with intermediate protection, management is delegated to a professional, but the family stays on as large shareholders to monitor the manager. In legal regimes with the weakest protection, the founder designates his heir to manage and ownership remains inside the family. This theory of separation of ownership from management includes the Anglo-Saxon and the Continental European patterns of corporate governance as special cases, and generates additional empirical predictions consistent with crosscountry evidence.

1945. John Y. Campbell and Glen B. Taksler
Equity Volatility and Corporate Bond Yields
Abstract | Paper
This paper explores the effect of equity volatility on corporate bond yields. Panel data for the late 1990's show that idiosyncratic firm-level volatility can explain as much cross-sectional variation in yields as can credit ratings. This finding, together with the upward trend in idiosyncratic equity volatility documented by Campbell, Lettau, Malkiel, and Xu (2001), helps to explain recent increases in corporate bond yields.

1946. John Y. Campbell and Joao F. Cocco
Household Risk Management and Optimal Mortgage Choice
Abstract | Paper
Home mortgages are the most significant financial contract for many households. The form of this contract is correspondingly important. This paper studies the choice between fixed-rate (FRM) and adjustable-rate (ARM) mortgages. In an environment with uncertain inflation, nominal FRMs have risky real capital value whereas ARMs have safe capital value. However ARMs can greatly increase the short-term variability of required real interest payments. This is a serious disadvantage of ARMs for households who face borrowing constraints and have only a small buffer stock of financial assets. The paper uses numerical methods to solve a life-cycle model with risky labor income and borrowing constraints, under alternative assumptions about available mortgage contracts. Households with large mortgages, risky labor income, high risk aversion, and a low probability of moving are more likely to prefer nominal FRMs. The paper also considers inflation-indexed FRMs. These mortgages remove the wealth risk of nominal FRMs without incurring the income risk of ARMs, and therefore are a superior vehicle for household risk management. The paper finds that the welfare gains of mortgage indexation can be very large.

1947. Xavier Gabaix and David Laibson
The 6D Bias and the Equity Premium Puzzle
Abstract | Paper
If decision costs lead agents to update consumption every D periods, then econometricians will find an anomalously low correlation between equity returns and consumption growth (Lynch 1996). We analytically characterize the dynamic properties of an economy composed of consumers who have such delayed updating. In our setting, an econometrician using an Euler equation procedure would infer a coefficient of relative risk aversion biased up by a factor of 6D. Hence with quarterly data, if agents adjust their consumption every D = 4 quarters, the imputed coefficient of relative risk aversion will be 24 times greater than the true value. High levels of risk aversion implied by the equity premium and violations of the Hansen-Jagannathan bounds cease to be puzzles. The neoclassical model with delayed adjustment explains the consumption behavior of shareholders. Once limited participation is taken into account, the model matches most properties of aggregate consumption and equity returns, including new evidence that the covariance between ln(Ct+h/Ct) and Rt+1 slowly rises with h.

1948. Edward L. Glaeser and Joseph Gyourko
The Impact of Zoning on Housing Affordability
Abstract | Paper
Does America face an affordable housing crisis and, if so, why? This paper argues that in much of America the price of housing is quite close to the marginal, physical costs of new construction. The price of housing is significantly higher than construction costs only in a limited number of areas, such as California and some eastern cities. In those areas, we argue that high prices have little to do with conventional models with a free market for land. Instead, our evidence suggests that zoning and other land use controls play the dominant role in making housing expensive.

1949.Alberto Alesina, Reza Baqir and Caroline Hoxby
Political Jurisdictions in Heterogeneous Communities
Abstract | Paper
We investigate the number and size of local political jurisdictions are determined, by focusing on the tradeoff between the benefits of economies of scale and the costs of a heterogeneous population. We consider heterogeneity in income, race, ethnicity, and religion, and we test the model using American school districts, school attendance areas, municipalities, and special districts. Using cross-sectional and panel analysis, we find very little evidence of tradeoffs between economies of scale and ethnic or religious heterogeneity. However, we find evidence of a tradeoff between economies of scale and income heterogeneity and particularly strong evidence of a tradeoff between economies of scale and racial heterogeneity. To clarify the direction of causality between heterogeneity and jurisdictions, we exploit shocks to racial heterogeneity generated by the two World Wars.

1950. Sylvie Demurger, Jeffrey D. Sachs, Wing Thye Woo, Shuming Bao, Gene Chang and Andrew Mellinger
Geography, Economic Policy and Regional Development in China
Abstract | Paper
Many studies of regional disparity in China have focused on the preferential policies received by the coastal provinces. We decomposed the location dummies in provincial growth regressions to obtain estimates of the effects of geography and policy on provincial growth rates in 1996–99. Their respective contributions in percentage points were 2.5 and 3.5 for the province-level metropolises, 0.6 and 2.3 for the northeastern provinces, 2.8 and 2.8 for the coastal provinces, 2.0 and 1.6 for the central provinces, 0 and 1.6 for the northwestern provinces, and 0.1 and 1.8 for the southwestern provinces. Because the so-called preferential policies are largely deregulation policies that have allowed coastal Chinese provinces to integrate into the international economy, it is far superior to reduce regional disparity by extending these deregulation policies to the interior provinces than by re-regulating the coastal provinces. Two additional inhibitions to income convergence are the household registration system, which makes the movement of the rural poor to prosperous areas illegal, and the monopoly state bank system that, because of its bureaucratic nature, disburses most of its funds to its large traditional customers, few of whom are located in the western provinces. Improving infrastructure to overcome geographic barriers is fundamental to increasing western growth, but increasing human capital formation (education and medical care) is also crucial because only it can come up with new better ideas to solve centuries-old problems like unbalanced growth.

1951. Simeon Djankov, Rafael La Porta, Florencio Lopez-de-Silanes, and Andrei Shleifer
Courts: The Lex Mundi Project
Abstract | Paper
In cooperation with Lex Mundi member law firms in 109 countries, we measure and describe the exact procedures used by litigants and courts to evict a tenant for non-payment of rent and to collect a bounced check. We use these data to construct an index of procedural formalism of dispute resolution for each country. We find that such formalism is systematically greater in civil than in common law countries. Moreover, procedural formalism is associated with higher expected duration of judicial proceedings, more corruption, less consistency, less honesty, less fairness in judicial decisions, and inferior access to justice. These results suggest that legal transplantation may have led to an inefficiently high level of procedural formalism, particularly in developing countries.

1952. George-Marios Angeletos and Laurent E. Calvet
Idiosyncratic Production Risk, Growth and the Business Cycle
Abstract | Paper
We introduce a neoclassical growth economy with idiosyncratic production risk and incomplete markets. The general equilibrium is characterized in closed form. Uninsurable production shocks introduce a risk premium on private equity and typically result in a lower steady-state level of capital than under complete markets. In the presence of such risks, the anticipation of low investment and high interest rates in the future discourages risk-taking and feeds back into low investment in the present. An endogenous macroeconomic complementarity thus arises, which slows down convergence and amplifies the magnitude and persistence of the business cycle. These results — contrasting sharply with those of Aiyagari (1994) and Krusell and Smith (1998) — highlight that idiosyncratic production or capital-income risk can have significant adverse effects on capital accumulation and aggregate volatility. Keywords: Capital income, Entrepreneurial risk, Fluctuations, Growth, Investment, Precautionary savings.

1953. Nicholas Barberis, Andrei Shleifer and Jeffrey Wurgler
Comovement
Abstract | Paper
A number of studies have identifed patterns of positive correlation of returns, or comovement, among different traded securities. We distinguish three views of such comovement. The traditional “fundamentals” view explains the comovement of securities through positive correlations in the rational determinants of their values, such as cash flows or discount rates. “Category-based” comovement occurs when investors classify different securities into the same asset class and shift resources in and out of this class in correlated ways. A related phenomenon of “habitat-based” comovement arises when a group of investors restricts its trading to a given set of securities, and moves in and out of that set in tandem. We present models of each of the three types of comovement, and then assess them empirically using data on stock inclusions into and deletions from the S&P 500 index. Index changes are noteworthy because they change a stock’s category and investor clientele (habitat), but do not change its fundamentals. We find that when a stock is added to the index, its beta and R-squared with respect to the index increase, while its beta with respect to stocks outside the index falls. The converse happens when a stock is deleted. These results are broadly supportive of the category and habitat views of comovement, but not of the fundamentals view. More generally, we argue that these non-traditional views may help explain other instances of comovement in the data.

1954. Edward L. Glaeser
The Governance of Not-for-Profit Firms
Abstract | Paper
Many factors including incentive-pay, powerful shareholders, and takeover threats push for-profits managers towards maximizing shareholder value. One of the most striking factors about non-profit firms is that they have no comparable governance institutions, and the only check on managers are boards that are themselves rarely responsible to anyone outside the firm. This essay discusses the implications of these weak governance institutions on non-profit behavior. A primary implication is that non-profits will often evolve into organizations that resemble workers’ cooperatives. The primary check on this tendency is the need of the organizations to compete in outside markets. After presenting a model of non-profit behavior, I look at four different sectors (hospitals, museums, universities and the church). All display significant signs of capture by elite workers, but all still perform their basic missions reasonably, probably because of market competition.

1955. Steve Berry, Oliver B. Linton, and Ariel Pakes
Limit Theorems for Estimating the Parameters of Differentiated Product Demand Systems
Abstract | Paper
We provide an asymptotic distribution theory for a class of Generalized Method of Moments estimators that arise in the study of differentiated product markets when the number of observations is associated with the number of products within a given market. We allow for three sources of error: the sampling error in estimating market shares, the simulation error in approximating the shares predicted by the model, and the underlying model error. The limiting distribution of the parameter estimator is normal provided the size of the consumer sample and the number of simulation draws grow at a large enough rate relative to the number of products. We specialise our distribution theory to the Berry, Levinsohn, and Pakes (1995) random coeffcient logit model and a pure characteristic model. The required rates differ for these two frequently used demand models. A small Monte Carlo study shows that the difference in asymptotic properties of the two models are reflected in the models' small sample properties. These differences impact directly on the computational burden of the two models.

1956. Edward L. Glaeser and Andrei Shleifer
The Curley Effect
Abstract | Paper
James Michael Curley, a four-time mayor of Boston, used wasteful redistribution to his poor Irish constituents and incendiary rhetoric to encourage richer citizens to emigrate from Boston, thereby shaping the electorate in his favor. Boston as a consequence stagnated, but Curley kept winning elections. We present a model of the Curley effect, in which inefficient redistributive policies are sought not by interest groups protecting their rents, but by incumbent politicians trying to shape the electorate through emigration of their opponents or reinforcement of class identities. The model sheds light on ethnic politics in the United States and abroad, as well as on class politics in many countries including Britain.

1957. Philippe Aghion, Albero Alesina and Francesco Trebbi
Endogenous Political Institutions
Abstract | Paper
Political institutions influence economic policy, but they are themselves endogenous since they are chosen, in some way, by members of the polity. An important aspect of institutional design is how much society chooses to delegate unchecked power to its leaders. If, once elected, a leader cannot be restrained, society runs the risk of a tyranny of the majority, if not the tyranny of a dictator. If a leader faces too many ex post checks and balances, legislative action is too often blocked. As our critical constitutional choice we focus upon the size of the minority needed to block legislation, or conversely the size of the (super)majority needed to govern. We analyze both “optimal” constitutional design and ”positive” aspects of this process. We derive several empirical implications which we then discuss.

1958. Alberto Alesina, Robert Barro and Silvana Tenreyro
Optimal Currency Areas
Abstract | Paper
As the number of independent countries increases and their economies become more integrated, we would expect to observe more multi-country currency unions. This paper explores the pros and cons for different countries to adopt as an anchor the dollar, the euro, or the yen. Although there appear to be reasonably well-defined euro and dollar areas, there does not seem to be a yen area. We also address the question of how trade and co-movements of outputs and prices would respond to the formation of a currency union. This response is important because the decision of a country to join a union would depend on how the union affects trade and co-movements.

1959. Alberto Alesina, Arnaud Devleeschauwer, William Easterly, Sergio Kurlat and Romain Wacziarg
Fractionalization
Abstract | Paper
We provide new measures of ethnic, linguistic and religious fractionalization for about 190 countries. These measures are more comprehensive than those previously used in the economics literature and we compare our new variables with those previously used. We also revisit the question of the effects of ethnic, linguistic and religious fractionalization on quality of institutions and growth. We partly confirm and partly modify previous results. The patterns of cross-correlations between potential explanatory variables and their different degree of endogeneity makes it hard to make unqualified statements about competing explanations for economic growth and the quality of government.

1960. Glenn Allison and Drew Fudenberg
Competing Auctions
Abstract | Paper
This paper studies the conditions under which two competing and otherwise identical markets or auction sites of different sizes can coexist in equilibrium, without the larger one attracting all of the smaller one’s patrons. We find that the range of equilibrium market sizes depends on the aggregate buyer-seller ratio, and also whether the markets are especially "thin."

1961. Drew Fudenberg and David K. Levine
The Nash Threats Folk Theorem With Communication and Approximate Common Knowledge In Two Player Games
Abstract | Paper
Abstract Not Available At This Time

1962.Jeffrey Ely, Drew Fudenberg and David K. Levine
When is Reputation Bad?
Abstract | Paper
In traditional reputation theory, reputation is good for the long-run player. In "Bad Reputation," Ely and Valimaki give an example in which reputation is unambiguously bad. This paper characterizes a more general class of games in which that insight holds, and presents some examples to illustrate when the bad reputation effect does and does not play a role. The key properties are that participation is optional for the short-run players, and that every action of the long-run player that makes the short-run players want to participate has a chance of being interpreted as a signal that the long-run player is "bad. We also broaden the set of commitment types, allowing many types, including the "Stackelberg type" used to prove positive results on reputation. Although reputation need not be bad if the probability of the Stackelberg type is too high, the relative probability of the Stackelberg type can be high when all commitment types are unlikely.

1963. Laurence Ball and N. Gregory Mankiw
The NAIRU in Theory and Practice
Abstract | Paper
This paper discusses the NAIRU - the non-accelerating inflation rate unemployment. It first considers the role of the NAIRU concept in business cycle theory, arguing that this concept is implicit in any model in which monetary policy influences both inflation and unemployment. The exact value of the NAIRU is hard to measure, however, in part because it changes over time. The paper then discusses why the NAIRU changes and, in particular, why it fell in the United States during the 1990s. The most promising hypothesis is that the decline in the NAIRU is attributable to the acceleration in productivity growth.

1964. Julie Holland Mortimer
The Effects of Revenue-Sharing Contracts on Welfare in Vertically-Separated Markets: Evidence from the Video Rental Industry
Abstract | Paper
In this study I analyze the implications of contractual innovation in vertically-separated industries, using the example of the video rental industry. Prior to 1998, video stores obtained inventory from movie distributors using simple linear pricing contracts. In 1998, revenue-sharing contracts, which include inventory restrictions, were widely adopted. I investigate the effect of using revenue-sharing contracts on firms' profits and consumer welfare, relative to linear pricing contracts. I analyze a new panel dataset of home video retailers that includes information on individual retailers' contract and inventory choices, weekly rentals and sales, and contract terms (prices and quantity restrictions) for 1,114 movie titles and 6,594 retailers in the U.S during each week of 1998 and 1999. A structural econometric model of firms' behavior is developed and estimated, and counterfactual experiments are performed. The results indicate that total upstream and downstream profits increase by three to six percent, and consumers benefit substantially when revenue-sharing contracts are adopted. I also examine the effects of the observed quantity restrictions. I find that these restrictions serve to increase profit for upstream firms and decrease profits for downstream firms, relative to revenue-sharing contracts without inventory restrictions.

1965.Gene M. Grossman and Elhanan Helpman
Outsourcing versus FDI in Industry Equilibrium?
Abstract | Paper
We study the determinants of the extent of outsourcing and of direct foreign investment in an industry in which producers need specialized components. Potential suppliers must make a relationship-specific investment in order to serve each prospective customer. Such investments are governed by imperfect contracts. A final-good producer can manufacture components for itself, but the per-unit cost is higher than for specialized suppliers. We consider how the size of the cost differential, the extent of contractual incompleteness, the size of the industry, and the relative wage rate affect the organization of industry production.

1966.Gene M. Grossman and Elhanan Helpman
Outsourcing in a Global Economy?
Abstract | Paper
We study the determinants of the location of sub-contracted activity in a general equilibrium model of outsourcing and trade. We model outsourcing as an activity that requires search for a partner and relationship-specific investments that are governed by incomplete contracts. The extent of international outsourcing depends inter alia on the thickness of the domestic and foreign market for input suppliers, the relative cost of searching in each market, the relative cost of customizing inputs, and the nature of the contracting environment in each country.

1967.Edward L. Glaeser, Jose Scheinkman, and Andrei Shleifer
The Injustice of Inequality
Abstract | Paper
In many countries, the operation of legal, political and regulatory institutions is subverted by the wealthy and the politically powerful for their own benefit. This subversion takes the form of corruption, intimidation, and other forms of influence. We present a model of such institutional subversion – focusing specifically on courts – and of the effects of inequality in economic and political resources on the magnitude of subversion. We then use the model to analyze the consequences of institutional subversion for the law and order environment in the country, as well as for capital accumulation and growth. We illustrate the model with historical evidence from Gilded Age United States and the transition economies of the 1990s. We also present some cross-country evidence consistent with the basic prediction of the model.

1968. Edward L. Glaeser, Bruce I. Sacerdote and Jose A. Scheinkman
The Social Multiplier
Abstract | Paper
In many cases, aggregate data is used to make inferences about individual level behavior. If there are social interactions in which one person’s actions influence his neighbor’s incentives or information, then these inferences are inappropriate. The presence of positive social interactions, or strategic complementarities, implies the existence of a social multiplier where aggregate relationships will overstate individual elasticities. We present a brief model and then estimate the size of the social multiplier in three areas: the impact of education on wages, the impact of demographics on crime and group membership among Dartmouth roommates. In all three areas there appears to be a significant social multiplier.

1969.Michael Ostrovsky and Michael Schwarz
Coordination under Uncertainty
Abstract | Paper
A decision maker needs to schedule several activities that take uncertain time to complete and are only valuable together. Some activities are bound to be finished earlier than others, thus incurring waiting costs. We show how to schedule activities optimally, how to give independent agents performing them incentives that implement the efficient schedule, how to form teams, and how to optimally reduce uncertainty when it is possible to do so at a cost. The paper offers insights into important economic decisions such as planning large projects and coordinating product development activities.

1970. Edward L. Glaeser
The Political Economy of Hatred
Abstract | Paper
What determines the intensity and objects of hatred? Hatred forms when people believe that out-groups are responsible for past and future crimes, but the reality of past crimes has little to do with the level of hatred. Instead, hatred is the result of an equilibrium where politicians supply stories of past atrocities in order to discredit the opposition and consumers listen to them. The supply of hatred is a function of the degree to which minorities gain or lose from particular party platforms, and as such, groups that are particularly poor or rich are likely to be hated. Strong constitutions that limit the policy space and ban specific anti-minority policies will limit hate. The demand for hatred falls if consumers interact regularly with the hated group, unless their interactions are primarily abusive. The power of hatred is so strong that opponents of hatred motivate their supporters by hating the haters.

1971. John Y. Campbell and Tuomo Vuolteenaho
Bad Beta, Good Beta
Abstract | Paper
This paper explains the size and value “anomalies” in stock returns using an economically motivated two-beta model. We break the beta of a stock with the market portfolio into two components, one reflecting news about the market’s future cash flows and one reflecting news about the market’s discount rates. Intertemporal asset pricing theory suggests that the former should have a higher price of risk; thus beta, like cholesterol, comes in “bad” and “good” varieties. Empirically, we find that value stocks and small stocks have considerably higher cash-flow betas than growth stocks and large stocks, and this can explain their higher average returns. The post- 1963 negative CAPM alphas of growth stocks are explained by the fact that their betas are predominantly of the good variety.

1972. John Y. Campbell and Motohiro Yogo
Efficient Tests of Stock Return Predictability
Abstract | Paper
Empirical studies have suggested that stock returns can be predicted by financial variables such as the dividend-price ratio. However, these studies typically ignore the high persistence of predictor variables, which can make first-order asymptotics a poor approximation in finite samples. Using a more accurate asymptotic approximation, we propose two methods to deal with the persistence problem. First, we develop a pretest that determines when the conventional t-test for predictability is misleading. Second, we develop a new test of predictability that results in correct inference regardless of the degree of persistence and is efficient compared to existing methods. Applying our methods to US data, we find that the dividend-price ratio and the smoothed earningsprice ratio are sufficiently persistent for conventional inference to be highly misleading. However, we find some evidence for predictability using our test, particularly with the earnings-price ratio. We also find evidence for predictability with the short-term interest rate and the long-short yield spread, for which the conventional t-test leads to correct inference.

1973. John Y. Campbell, George Chacko, Jorge Rodriguez and Luis M. Viceira
Strategic Asset Allocation in a Continuous-Time VAR Model
Abstract | Paper
This note derives an approximate solution to a continuous-time intertemporal portfolio and consumption choice problem. The problem is the continuous-time equivalent of the discrete-time problem studied by Campbell and Viceira (1999), in which the expected excess return on a risky asset follows an AR(1) process, while the riskless interest rate is constant. The note also shows how to obtain continuous-time parameters that are consistent with discrete-time econometric estimates. The continuous-time solution is numerically close to that of Campbell and Viceira and has the property that conservative long-term investors have a large positive intertemporal hedging demand for stocks.

1974. John Y. Campbell
Consumption-Based Asset Pricing
Abstract | Paper
This chapter reviews the behavior of financial asset prices in relation to consumption. The chapter lists some important stylized facts that characterize US data, and relates them to recent developmenets in equilibrium asset pricing theory. Data from other countries are examined to see which features of the US experience apply more generally. The chapter argues that to make sense of asset market behavior one needs a model in which the market price of risk is high, time-varying, and correlated with the state of the economy. Models that have this feature, including models with habit-formation in utility, heterogeneous investors, and irrational expectations, are discussed. The main focus is on stock returns and short-term real interest rates, but bond returns are also considered.

1975. Alberto Alesina
The Size of Countries: Does it Matter?
Abstract | Paper
Borders are a man made institution, and as such their shape cannot be taken as part of the physical landscape. The size of countries is endogenous to politico economic forces. This paper discusses recent efforts by economists to study three related question: what determines the evolution of the size of countries? Does size matter for economic success? Given the trend toward decentralization and of creation of supernational unions like the EU, is the meaning of national borders evolving?

1976. Allen N. Berger, Nathan H. Miller, Mitchell A. Petersen, Raghuram G. Rajan and Jeremy C. Stein
Does Function Follow Organzizational Form? Evidence From the Lending Practices of Large and Small Banks
Abstract | Paper
Theories based on incomplete contracting suggest that small organizations may do better than large organizations in activities that require the processing of soft information. We explore this idea in the context of bank lending to small firms, an activity that is typically thought of as relying heavily on soft information. We find that large banks are less willing than small banks to lend to informationally “difficult” credits, such as firms that do not keep formal financial records. Moreover, controlling for the endogeneity of bank-firm matching, large banks lend at a greater distance, interact more impersonally with their borrowers, have shorter and less exclusive relationships, and do not alleviate credit constraints as effectively. All of this is consistent with small banks being better able to collect and act on soft information than large banks. The opinions in this paper do not necessarily reflect those of the Federal Reserve Board or its staff. This work has been supported by the National Science Foundation (Rajan, Stein), and the George J. Stigler Center for Study of the State and Economy (Rajan). Thanks also to seminar participants at Yale, the Federal Reserve Bank of New York, Tulane, Babson, the University of Illinois, the Federal Reserve Bank of Chicago Bank Structure Conference, the NBER and the Western Finance Association meetings, as well as to Abhijit Banerjee, Michael Kremer, David Scharfstein, Andrei Shleifer, Greg Udell, Christopher Udry and James Weston for helpful comments and suggestions.

1977. Malcolm Baker and Jeremy C. Stein
Market Liquidity as a Sentiment Indicator
Abstract | Paper
We build a model that helps explain why increases in liquidity-such as lower bid-ask spreads, a lower price impact of trade, or higher turnoverpredict lower subsequent returns in both firm-level and aggregate data. The model features a class of irrational investors, who underreact to the information contained in order flow, thereby boosting liquidity. In the presence of short-sales constraints, high liquidity is a symptom of the fact that the market is dominated by these irrational investors, and hence is overvalued. This theory can also explain how managers might successfully time the market for seasoned equity offerings, by simply following a rule of thumb that involves issuing when the SEO market is particularly liquid. Empirically, we find that: i) aggregate measures of equity issuance and share turnover are highly correlated; yet ii) in a multiple regression, both have incremental predictive power for future equal-weighted market returns.

1978. Malcolm Baker, Jeremy C. Stein and Jeffrey Wurgler
When Does the Market Matter? Stock Prices and the Investsment of Equity-Dependent Firms
Abstract | Paper
We use a simple model to outline the conditions under which corporate investment will be sensitive to non-fundamental movements in stock prices. The key cross-sectional prediction of the model is that stock prices will have a stronger impact on the investment of firms that are “equity dependent” – firms that need external equity to finance their marginal investments. Using an index of equity dependence based on the work of Kaplan and Zingales (1997), we find strong support for this prediction. In particular, firms that rank in the top quintile of the KZ index have investment that is almost three times as sensitive to stock prices as firms in the bottom quintile. We also verify several other predictions of the model.

1979. Edward L. Glaeser and Jessse M. Shapiro
The Benefits of the Home Mortgage Interest Deduction
Abstract | Paper
The home mortgage interest deduction creates incentives to buy more housing and to become a homeowner, and the case for the deduction rests on social benefits from housing consumption and homeownership. There is little evidence suggesting large externalities from the level of housing consumption, but there appear to be externalities from homeownership. Externalities from living around homeowners are far too small to justify the deduction. Externalities from homeownership are larger, but the home mortgage interest deduction is a particularly poor instrument for encouraging homeownership since it is targeted at the wealthy, who are almost always homeowners. The irrelevance of the deduction is supported by the time series which shows that the ownership subsidy moves with inflation and has changed significantly between 1960 and today, but the homeownership rate has been essentially constant.

1980.Michael Schwarz
Investment Tournaments: Should a Rational Agent Put All His Eggs in One Basket?
Abstract | Paper
Investment tournament is a type of decision problem introduced and studied in this paper. These problems involve allocation of investments among several alternatives whose values are subject to exogenous shocks. The payoff to the decision maker is a weighted sum of final values of each alternatives with weights convex in final values. (1) For the case of constant returns to scale it is optimal to allocate all resources to the most promising alternative.(2) In tournaments for a promotion the agents would rationally choose to put forth more effort in the early stage of the tournament in a bid to capture a larger share of mentoring resources.

1981. Sendhil Mullainathan and Andrei Shleifer
Media Bias
Abstract | Paper
There are two different types of media bias. One bias, which we refer to as ideology, reflects a news outlet's desire to affect reader opinions in a particular direction. The second bias, which we refer to as spin, reflects the outlet's attempt to simply create a memorable story. We examine competition among media outlets in the presence of these biases. Whereas competition can eliminate the effect of ideological bias, it actually exaggerates the incentive to spin stories.

1982. Michael Schwarz, Edward Lazear and Sherwin Rosen
Russia in Transition
Abstract | Paper
The history of transition in Russia is analyzed in this paper. Issues ranging from managerial incentives to the changing structure of trade are considered in an attempt to present a comprehensive sketch of the state of the Russian economy. The transition in Russia can be compared with demobilization. Demobilization process is often accompanied by large output declines. For instance, during the post World War II demobilization the US GNP declined by 25%. In light of this, the great contraction of the Russian economy does not appear to be a major outlier when the militaristic nature of the Soviet economy is taken into account. We point out a previously unexplored factor detrimental for incentives of Russian managers, which we call soft taxation. Soft taxation is a free market analog of soft-budget constraints. Due to the inefficiency of institutions, managers have an incentive to take costly actions in order to signal that the profitability of the firm is low. Also, we suggest a few indices of aggregate economic shocks including one based on the structure of foreign trade. The values of the indices of aggregate shocks for the Russian economy are compared to those of several other countries. The data seem to indicate that the changes in the structure of Russian trade have been far greater than in non-transition economies. However, other indices of economic adjustment do not paint a picture of a rapid transition.

1983. Alberto Alesina and George-Marios Angeletos
Fairness and Redistribution: US versus Europe
Abstract | Paper
Different beliefs about how fair social competition is and what determines income inequality, influence the redistributive policy chosen democratically in a society. But the composition of income in the first place depends on equilibrium tax policies. If a society believes that individual effort determines income, and that all have a right to enjoy the fruits of their effort, it will chose low redistribution and low taxes. In equilibrium effort will be high, the role of luck limited, market outcomes will be quite fair, and social beliefs will be self-fulfilled. If instead a society believes that luck, birth, connections and/or corruption determine wealth, it will tax a lot, thus distorting allocations and making these beliefs self-sustained as well. We show how this interaction between social beliefs and welfare policies may lead to multiple equilibria or multiple steady states. We argue that this model can contribute to explain US vis a vis continental European perceptions about income inequality and choices of redistributive policies.

1984. N. Gregory Mankiw and Ricardo Reis
What Measure of Inflation Should a Central Bank Target?
Abstract | Paper
This paper assumes that a central bank commits itself to maintaining an inflation target and then asks what measure of the inflation rate the central bank should use if it wants to maximize economic stability. The paper first formalizes this problem and examines its microeconimic foundations. It then shows how the weight of a sector in the stability price index depends on the sector's characteristics, including size, cyclical sensitivity, sluggishness of price adjustment, and magnitude of sectoral shocks. When a numerical illustration of the problem is calibrated to U.S. data, one tentative conclusion is that a central bank that wants to achieve maximum stability of economic activity should use a price index that gives substantial weight to the level of nominal wages.

1985. Edward L. Glaeser
Does Rent Control Reduce Segregation?
Abstract | Paper
Advocates of rent control often argue that rent control aids the mixing of rich and poor, and perhaps of the races as well. Economic theory does not necessarily predict that rent control will reduce segregation. The best case for rent control as an aid to integration is that it creates pockets of low rent (and low quality) apartments in expensive cities. However, by creating an excess of demand over supply, rent control ensures that apartments will be allocated on the basis of landlord preferences, which may in fact be segregationist. Furthermore, when rent control induces poor renters to live in rich cities, those poor renters are generally older, long term renters, who are less likely to have young children living at home and are less likely to benefit most from integration. Empirically, rent control seems to have allowed some poorer (and older) tenants to live in expensive Manhattan, but rent control in the declining cities of New Jersey seems to have increased the isolation of the poor. Rent control is a very socially costly means of occasionally getting integration, and housing vouchers or supply-side policies seem likely to be much more effective.

1986. Susanto Basu, John Fernald and Miles Kimball
Are Technology Improvements Contractionary?
Abstract | Paper
Yes. We construct a measure of aggregate technology change, controlling for imperfect competition, varying utilization of capital and labor, and aggregation effects. On impact, when technology improves, input use falls sharply, and output may fall slightly. With a lag of several years, inputs return to normal and output rises strongly. We discuss what models could be consistent with this evidence. For example, standard one-sector real-business-cycle models are not, since they generally predict that technology improvements are expansionary, with inputs and (especially) output rising immediately. However, the evidence is consistent with simple sticky-price models, which predict the results we find: When technology improves, input use generally falls in the short run, and output itself may also fall.

1987. Gene M. Grossman and Elhanan Helpman
Managerial Incentives and the International Organization of Production
Abstract | Paper
We develop a model in which the heterogeneous firms in an industry choose their modes of organization and the location of their subsidiaries or suppliers. We assume that the principals of a firm are constrained in the nature of the contracts they can write with suppliers or employees. Our main result concerns the sorting of firms with different productivity levels into different organizational forms. We use the model to examine the implications of falling trade costs for the relevant prevalence of outsourcing and foreign direct investment.

1988. Keisuke Hirano and Jack R. Porter
Asymptotic Efficiency in Parametric Structural Models with Parameter-Dependent Support
Abstract | Paper
In certain auction, search, and related models, the boundary of the support of the observed data depends on some of the parameters of interest. For such nonregular models, standard asymptotic distribution theory does not apply. Previous work has focused on characterizing the nonstandard limiting distributions of particular estimators in these models. In contrast, we study the problem of constructing e cient point estimators. We show that the maximum likelihood estimator is generally ine cient, but that the Bayes estimator is e cient according to the local asymptotic minmax criterion for conventional loss functions. We provide intuition for this result using Le Cam's limits of experiments framework.

1989. Jack Porter
Asymptotic Bias and Optimal Convergence Rates for Semiparametric Kernel Estimators in the Regression Discontinuity Model
Abstract | Paper
The regression discontinuity model has recently become a commonly applied framework for empirical work in economics. Hahn, Todd, and Van der Klaauw (2001) provide a formal development of the identification of a treatment effect in this framework and also note the potential bias problems in its estimation. This bias difficulty is the result of a particular feature of the regression discontinuity treatment effect estimation problem that distinguishes it from typical semiparametric estimation problems where smoothness is lacking. Here, the discontinuity is not simply an obstacle to overcome in estimation; instead, the size of discontinuity is itself the object of estimation interest. In this paper, I derive the optimal rate of convergence for estimation of the regression discontinuity treatment effect. The optimal rate suggests that the appropriate choice of estimator the bias difficulties are no worse than would be found in the usual nonparametric conditional mean estimation problem (at an interior point of the covariate support). Two estimators are proposed that attain the optimal rate under varying conditions. One estimator is based on Robinson's (1988) partially linear estimator. The other estimator uses local polynomial estimation and is optimal under a broader set of conditions.

1990. Alberto Alesina, Silvia Ardagna, Giuseppe Nicoletti and Fabio Schiantarelli
Regulation and Investment
Abstract | Paper
One commonly held view about the di¤erence between continental European countries and other OECD economies, especially the United States, is that the heavy regulation of the former reduces their growth. Using newly assembled data on regulation in several sectors of many OECD countries, we provide substantial and robust evidence that various measures of regulation in the product markets, concerning in particular entry barriers, are negatively related to investment. The policy implication of our analysis is clear: regulatory reforms that liberalize entry are very likely to spur investment.

1991. Ariel Pakes
A Reconsideration of Hedonic Price Indexes with an Application to PC's
Abstract | Paper
This paper begins by comparing hedonic price indexes to the standard matched model index. The matched model index is formed as an average of the price changes of the goods in the sample in the base period that remain on the sampled stores’ shelves in the comparison period. Since goods that do not remain on the shelves tend to be goods whose market value has fallen, the matched model index tends to select from the right tail of the distribution of price changes. The hedonic index corrects for the change in value of the observed characteristics of the goods that exit. Moreover we provide conditions which insure that the hedonic can be justified as an upper bound to the compensating variation (which is the standard rational for the matched model index when no goods exit). The paper then explains how the hedonic index can be constructed from exactly the same data that is currently used to construct the CPI. The matched model index can have lower variance than the hedonic when both are computed from this data, but in those cases we show that there is a hybrid hedonic index which has the selection correction properties of the hedonic and the variance reduction properties of the matched model index. We illustrate with a new study of price indexes for PC’s. The hedonic index shows steep price declines which follow the pattern of technological change in this market. On average, the matched model indexes indicate no price fall at all and one commonly used matched model index is negatively correlated with the hedonic. We also consider alternative indexes. Of these the one that works well is a “Paasche style” hedonic that we introduce. Its advantage is that since it does not require computation of the current period’s hedonic function, it is easier to use when monthly timetables need to be met.

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