Knowledge that Transforms

The authors attempt to account for the covariances between stock markets and to assess their integration. They estimate a factor model for sixteen national stock market returns whose volatility is induced by changing volatility in the factors. Unanticipated returns depend on innovations in economic variables and 'unobservable' factors. Assets risk premia are linear combinations of the factors risk premia. The authors find that idiosyncratic risk is priced and the 'price of risk' is different across stock markets. Besides, only a small proportion of their covariances can be accounted for by 'observable' economic variables. Correlation changes are driven primarily by movements in 'unobservables.' Copyright 1994 by The Econometric Society.

FLWNO

The authors characterize the symmetric equilibria of an investment game with a pure informational externality. When the period length is very short, the game ends very quickly; with positive probability, an informational cascade (herding) causes an investment collapse. As the period length increases, the possibility of herding disappears. As the number of players increases, the rate of investment and the information flow are eventually independent of the number of players; adding more players simply increases the number who delay. In the limit, a period of low investment is followed by either an investment surge or a collapse. Copyright 1994 by The Econometric Society.

IN AN INTERESTING RECENT PAPER, Sarin and Wakker (1992) (henceforth S-W) have provided a new axiomatization of expected utility maximization with (CEU). Its simplicity is attractive in that it provides a constructive interpretation of the role of capacities and Choquet integration in the main representation theorem. An important issue raised by the paper is the interpretation of the key Axiom P4 (Cumulative Dominance). S-W suggest an appreciation of the axiom as an adaptation of principles to nonadditive-probability contexts, most eloquently on page 1260. If viable, such an interpretation would supply the CEU model with a powerful intuitive foundation that has been lacking so far. This note argues that a interpretation can be maintained only at the price of either an arbitrary choice of specification which undermines its intuitive force or, alternatively, of an unintended restriction of the class of characterized preferences. Two logically independent arguments are presented. The first points out an arbitrariness in the of the more-likely-than relation in terms of preferences (Proposition 1). The second shows a similar arbitrariness in the of a stochastic dominance relation in terms of a more-likely-than relation (Proposition 2). In each case, the invoked symmetry conditions yield a characterization of CEU preferences with symmetric capacities, a nontrivial generalization of the SEU model that has received little attention in the literature. For notation and definitions, the reader is referred to S-W's paper. S-W's concern is to develop an intuitively convincing axiomatization of CEU-representable preference relations. Their key Axiom P4 is formulated in terms of a more-likelythan relation > on the algebra v of events that is defined in terms of the preference relation a on the set of acts Y To facilitate the subsequent discussion, their definition is introduced here formally as a condition on the pair of relations (a, >):

The paper analyzes a first price, sealed bid auction with a random reservation price where the object has an unknown common value, but one buyer has better information than the others. We permit the reservation price to be correlated with the information of the informed buyer, which reflects both his assessment of the value of the object and probability of rejection at any bid. Assuming all random variables are affiliated, we establish the following results. (1) The rate of increase in the distribution of the uninformed bidder is never greater than the rate of increase in the distribution of the informed bid. (2) The distributions are identical at bids above the support of the reservation price. (3) The informed buyer is more likely to submit low bids. We demonstrate that these restrictions are satisfied by bid data from the federal sales of offshore drainage leases.

We establish conditions which (in various settings) guarantee the existence of equilib-ria described by ergodic Markov processes with a Borel state space S. Let 9(S) denote the probability measures on S, and let s- G(s) c 4?(S) be a (possibly empty-valued) correspondence with closed graph characterizing intertemporal consistency, as prescribed by some particular model. A nonempty measurable set J c S is self-justified if G(s) n 9?(J) is not empty for all s E J. A time-homogeneous Markov equilibrium (THME) for G is a self-justified set J and a measurable selection TI: J-9 _(J) from the restriction of G to J. The paper gives sufficient conditions for existence of compact self-justified sets, and applies the theorem: If G is convex-valued and has a compact self-justified set, then G has an THME with an ergodic measure. The applications are (i) stochastic overlapping generations equilibria, (ii) an extension of the Lucas (1978) asset market equilibrium mnodel to the case of heterogeneous agents, and (iii) equilibria for discounted stochastic games with uncountable state spaces.

The new economics of regulation is an application of the principal-agent methodology to the contractual relationship between regulators and regulated firms. After a critique of the traditional paradigms of regulation from the point of view of information economics a canonical model of regulation under asymmetric information is developed. A survey of the main results obtained in the new economics of regulation is then provided, in particular concerning the implementation of optimal contracts by a menu of linear contracts, the dichotomy between pricing and cost reimbursement rules, the auctioning of incentive contracts, the dynamics of contracting under limited commitment, and the hierarchical problems in regulation. Empirical implications are then discussed and avenues of further research are described in the conclusion.