Knowledge that Transforms

This paper considers the enforceability of employment contracts when employees' performance cannot be verified in court so that piece-rate contracts are not legally enforceable. Part I shows that there exists a variety of self-enforcing implicit contracts, modelled as perfect equilibria in a repeated game, and characterizes all the wage and performance outcomes that can be implemented. Implementation requires a strictly positive surplus from employment, the form of the contract depending on how this surplus is divided between firm and employee. Piece-rate contracts, and contracts with an informally agreed bonus, can be made self-enforcing but the use of severance pay and bonding does not extend the set of implementable allocations. The resulting contracts resemble actual labor contracts more than do the contracts in standard principal-agent models. Part II analyses market equilibrium with these contracts, also modelled as perfect equilibria in a repeated game, and shows that many such equilibria exist. Unfilled vacancies and unemployed workers can co-exist despite the existence of contracts that are potentially mutually beneficial. For those jobs that are filled, any division of the potential surplus is possible so that the market can have, at the same time, involuntary unemployment and vacancies that are unfilled despite filled jobs earning positive profits. As a criterion for selecting equilibria, a notion of renegotiation proofness is applied. Then either all workers are employed or all jobs filled but any division of the potential surplus is still possible. The paper explores what further restrictions on beliefs give rise to a Walrasian outcome, in which all the potential surplus goes to the short side of the market, and to an efficiency wage type outcome, in which the potential surplus goes to the long side.

A test for the ex ante efficiency of a given portfolio of assets is analyzed. The relevant statistic has a tractable small sample distribution. Its power function is derived and used to study the sensitivity of the test to the portfolio choice and to the number of assets used to determine the ex post mean-variance efficient frontier. Several intuitive interpretations of the test are provided, including a simple mean-standard deviation geometric explanation. A univariate test, equivalent to our multivariate-based method, is derived, and it suggests some useful diagnostic tools which may explain why the null hypothesis is rejected. Empirical examples suggest that the multivariate approach can lead to more appropriate conclusions than those based on traditional inference which relies on a set of dependent univariate statistics. Copyright 1989 by The Econometric Society.

Altruistic parents make choices of family size along with decisions about consumption and intergenerational transfers. The authors apply this framework to a closed economy, where the determination of interest rates and wage rates is simultaneous with the determination of population growth and the accumulation of capital. Thus, they extend the literature on optimal economic growth to allow for optimizing choices of fertility and intergenerational transfers. The authors use the model to assess the effects of child-rearing costs, the tax system, the conditions of technology and preferences, and shocks to the initial levels of population and the capital stock. Copyright 1989 by The Econometric Society.

Multi-period decisions are decisions which determine an individual's payoffs in several periods in the future. This paper examines the theoretical foundations of the prevalent weighted average assumption. More specifically, we use a multi-period interpretation of the famous Ellsberg paradox in decision under uncertainty to show that in many cases of interest additively-separable functionals (in general) and weighted average ones (in particular) do not seem appropriate for the representation of the decision maker's preferences. We then suggest replacing the sure-thing principle, which may be used to axiomatize a weighted average functional, by a weaker version of it. Using the weakened axiom in Schmeidler's nonadditive measure model (reinterpreted for the multi-period context) yields an axiomatization of a larger class of decision rules which are representable by a weighted average of the utility in each period und the utility variation between each two consecutive periods. The weighted average assumption is a special case of the generalized model, a case in which the decision maker is variation neutral. Similarly, we define and characterize variation aversion and variation liking, and show an example of the economic implications of these properties.

This paper presents a model of the business cycle with perfect foresight where the mere presence of inventories is responsible for the appearance of the cycle. The basic assumption of the model is that the price system does not adjust instantaneously to its competitive value. Then inventory holding destabilizes the tâtonnement dynamics and creates the cycle. A Wicksellian cumulative process generates both the booms, where the real rate of return on cash is smaller than the natural rate of interest obtained by the inventory holders, and the recessions, where inventories are dominated by money balances.

A. Ronald Gallant, George Tauchen, Seminonparametric Estimation of Conditionally Constrained Heterogeneous Processes: Asset Pricing Applications, Econometrica, Vol. 57, No. 5 (Sep., 1989), pp. 1091-1120

ABSTRACT This paper analyzes the relation of stock volatility with real and nominal macroeconomic volatility, economic activity, financial leverage, and stock trading activity using monthly data from 1857 to 1987. An important fact, previously noted by Officer (1973) , is that stock return variability was unusually high during the 1929–1939 Great Depression. While aggregate leverage is significantly correlated with volatility, it explains a relatively small part of the movements in stock volatility. The amplitude of the fluctuations in aggregate stock volatility is difficult to explain using simple models of stock valuation, especially during the Great Depression.