Knowledge that Transforms

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We provide a practical method to estimate the payoff functions of players in complete information, static, discrete games. With respect to the empirical literature on entry games originated by Bresnahan and Reiss (1990) and Berry (1992), the main novelty of our framework is to allow for general forms of heterogeneity across players without making equilibrium selection assumptions. We allow the effects that the entry of each individual airline has on the profits of its competitors, its “competitive effects,” to differ across airlines. The identified features of the model are sets of parameters (partial identification) such that the choice probabilities predicted by the econometric model are consistent with the empirical choice probabilities estimated from the data. We apply this methodology to investigate the empirical importance of firm heterogeneity as a determinant of market structure in the U.S. airline industry. We find evidence of heterogeneity across airlines in their profit functions. The competitive effects of large airlines (American, Delta, United) are different from those of low cost carriers and Southwest. Also, the competitive effect of an airline is increasing in its airport presence, which is an important measure of observable heterogeneity in the airline industry. Then we develop a policy experiment to estimate the effect of repealing the Wright Amendment on competition in markets out of the Dallas airports. We find that repealing the Wright Amendment would increase the number of markets served out of Dallas Love.

I study asset prices in a two-agent macroeconomic model with two key features: limited stock market participation and heterogeneity in the elasticity of intertemporal substitution in consumption (EIS). The model is consistent with some prominent features of asset prices, such as a high equity premium, relatively smooth interest rates, procyclical stock prices, and countercyclical variation in the equity premium, its volatility, and in the Sharpe ratio. In this model, the risk-free asset market plays a central role by allowing non-stockholders (with low EIS) to smooth the fluctuations in their labor income. This process concentrates non-stockholders' labor income risk among a small group of stockholders, who then demand a high premium for bearing the aggregate equity risk. Furthermore, this mechanism is consistent with the very small share of aggregate wealth held by non-stockholders in the U.S. data, which has proved problematic for previous models with limited participation. I show that this large wealth inequality is also important for the model's ability to generate a countercyclical equity premium. When it comes to business cycle performance, the model's progress has been more limited: consumption is still too volatile compared to the data, whereas investment is still too smooth. These are important areas for potential improvement in this framework.

We develop a theory of optimal stopping under Knightian uncertainty. A suitable martingale theory for multiple priors is derived that extends the classical dynamic programming or Snell envelope approach to multiple priors. We relate the multiple prior theory to the classical setup via a minimax theorem. In a multiple prior version of the classical model of independent and identically distributed random variables, we discuss several examples from microeconomics, operation research, and finance. For monotone payoffs, the worst-case prior can be identified quite easily with the help of stochastic dominance arguments. For more complex payoff structures like barrier options, model ambiguity leads to stochastic changes in the worst-case beliefs.

As the record of Fed interventions from December 2007 to December 2008 make abundantly clear, a foremost concern of monetary authorities in responding to the financial crisis has been to avoid a repeat of the great depression, and especially a repeat of the monetary contraction identified as the major cause of the 1930s depression. The Fed has shown tremendous resourcefulness and inventiveness in its liquidity injections, considerably widening the collateral eligible under the discount window and the term auction facility, and setting up new programs targeted at primary dealers, the commercial paper market and money market funds. At the same time it has stepped in to offer guarantees on assets held by some financial institutions (e.g., Citigroup) to avoid their bankruptcy.This unprecedented intervention has had the intended effect of averting a major systemic financial meltdown and it has kept some critical financial institutions afloat. Yet, until now, banks have mostly responded by cutting new lending and hoarding liquidity, so that the ultimate goal of forestalling a credit crunch has not been achieved. For the most part, banks also are still holding most of the toxic assets that have undermined the market's confidence in the soundness of the banking system. Moreover, the Fed has put its balance sheet at risk, increasing the assets it holds from $851 billion in the summer of 2007 to $2.245 trillion at the end of 2008. Finally, the massive public liquidity injection has also had the effect of crowding out private liquidity and private capital as an alternative source of funding for banks.These side effects of the public liquidity injection may undermine the effectiveness of public policy and may also impose substantial costs on the real economy. It is therefore important to explore, with the benefit of hindsight, whether less costly approaches to public liquidity injections are available. This is what we intend to do in this paper, by relying on the analytical framework we developed in Bolton, Santos, and Scheinkman (2008) (BSS).

We develop a theory of resource management where the degree to which countries escape the tragedy of the commons is endogenously determined and explicitly linked to changes in world prices and other possible effects of market integration. We show how changes in world prices can move some countries from de facto open access situations to ones where management replicates that of an unconstrained social planner. Not all countries can follow this path of institutional reform and we identify key country characteristics (mortality rates, resource growth rates, technology) to divide the world's set of resource rich countries into Hardin, Ostrom and Clark economies. Hardin economies are not able to manage their renewable resources at any world price, have zero rents and suffer from the tragedy of the commons. Ostrom economies exhibit de facto open access and zero rents for low resource prices, but can maintain a limited form of resource management at higher prices. Clark economies can implement fully efficient management and do so when resource prices are sufficiently high. The model shows heterogeneity in the success of resource management is to be expected, and neutral technological progress works to undermine the efficacy of property rights institutions.

The modern world is the product of two momen tous changes: the Industrial Revolution of 1800, which brought sustained efficiency advances in economies, and the Demographic Transition of 1900, which channeled those efficiency advances mainly into increased income per capita, instead of increases in population. How these revolutions were connected has been a persistent unsolved puzzle in the history of growth. The Demographic Transition was achieved without any improve ment in contraceptive technologies from those of 1800 and earlier. It was a possibility for all preindustrial societies. Why did it occur only after the Industrial Revolution? The key component of the Malthusian econ

Economists generally assume that the state has sufficient institutional capacity to support markets and levy taxes. This paper develops a framework where “policy choices” in market regulation and taxation are constrained by past investments in legal and fiscal capacity. It studies the economic and political determinants of such investments, demonstrating that legal and fiscal capacity are typically complements. The results show that, among other things, common interest public goods, such as fighting external wars, as well as political stability and inclusive political institutions, are conducive to building state capacity. Some correlations in cross-country data are consistent with the theory.

Managers often face a choice between authority and persuasion. In particular, since a firm’s formal and relational contracts and its culture and norms are quite rigid in the short term, a manager who needs to prevent an employee from undertaking the wrong action has the choice between either trying to persuade this employee or relying on interpersonal authority. 1 Simon (1947) noted, for example, that ‘when... disagreement is not resolved by discussion, persuasion, or other means of conviction, then it must be decided by the authority of one or the other participant ’ and that ‘in actual practice [...] authority is liberally admixed with suggestion and persuasion. ’ Obviously, in choosing between persuasion and authority the manager makes a cost-benefit trade-off. This paper studies that trade-off, focusing in particular on agency conflicts that originate in open disagreement, in the sense of differing priors. To that purpose, I will study a setting in which a principal and an agent are involved in a project. The project’s outcome depends on decisions by both the principal and the agent and also depends on complementary private effort by the agent. A key issue is that the principal and agent may openly disagree on which decisions are most likely to lead to a success, even though no player has private information, i.e. the players have differing

Risk Preferences in the PSID: Individual Imputations and Family Covariation by Miles S. Kimball, Claudia R. Sahm and Matthew D. Shapiro. Published in volume 99, issue 2, pages 363-68 of American Economic Review, May 2009