Knowledge that Transforms

How public pension plan assets should be invested is an important but unsettled question. Alicia H. Munnell and Mauricio Soto (2007) find that the share of state and local (S&L) plan assets held in equities has grown over time largely in parallel with private sector practices, from an average of about 40 percent in the late 1980s to about 70 percent in 2007. This exposure led to a loss of an estimated $1 trillion dollars following the decline of the stock market from October 2007 to October 2008 (Munnell et. al., 2008). Nevertheless, some observers endorse the standard practice of investing heavily in higher yielding but riskier equities, reasoning that the higher average returns will reduce future required tax receipts and also help to reduce under-funding over time. Others advocate a more conservative approach that reduces the volatility of funding levels and the likelihood of severe shortfalls during economic downturns when government resources are already constrained (e.g., Lawrence N. Bader and Jeremy Gold, 2007). The accounting rules for public pensions create a perverse incentive to invest in stocks: since projected liabilities are discounted at the expected return on assets 1

The central insight of asset pricing is that a security's value depends both on its distribution of payoffs across economic states and on state prices. In fixed income markets, many investors focus exclusively on estimates of expected payoffs, such as credit ratings, without considering the state of the economy in which default occurs. Such investors are likely to be attracted to securities whose payoffs resemble economic catastrophe bonds—bonds that default only under severe economic conditions. We show that many structured finance instruments can be characterized as economic catastrophe bonds, but offer far less compensation than alternatives with comparable payoff profiles.

This paper derives empirically tractable formulas for the welfare effects of fare adjustments in passenger peak and off-peak rail and bus transit, and for optimal pricing of those services. The formulas account for congestion, pollution, accident externalities, scale economies, and agency adjustment of transit service offerings. We apply them using parameter values for Washington (DC), Los Angeles, and London. The results support the efficiency of the large current fare subsidies; even starting with fares at 50 percent of operating costs, incremental fare reductions are welfare improving in almost all cases. These findings are robust to alternative assumptions and parameters.

This paper develops a model in which a desire to avoid criticism prompts otherwise public-spirited bureaucrats to behave inefficiently. Decisions are taken to keep interest groups quiet and to keep mistakes out of the public eye. The policy implications of this “minimal squawk” behavior are at odds with the view that agencies should be structured to minimize the threat of “capture.” An empirical test using data from US State Public Utility Commissions rejects the capture hypothesis and is consistent with the squawk hypothesis: longer PUC terms of office are associated with a higher incidence of rate reviews and lower household electricity bills.

People exhibit peer-induced fairness concerns when they look to their peers as a reference to evaluate their endowments. We analyze two independent ultimatum games played sequentially by a leader and two followers. With peer-induced fairness, the second follower is averse to receiving less than the first follower. Using laboratory experimental data, we estimate that peer-induced fairness between followers is two times stronger than distributional fairness between leader and follower. Allowing for heterogeneity, we find that 50 percent of subjects are fairness-minded. We discuss how peer-induced fairness might limit price discrimination, account for low variability in CEO compensation, and explain pattern bargaining.

The recent turmoil on credit markets has drawn attention to the risk management function. On many trading oors around the world, traders have been writing insurance against rare events: examples include keeping long positions on CDO tranches or selling protection against default (CDS). In normal times, it is the role of risk management to ensure that the received insurance premia are not entirely considered as income, and that enough capital is set aside to protect the institution against the risk that it is taking. In the period that led to the current crisis, however, risk management has failed to play this role.1 This is particularly troubling as the nance industry is one that has embraced the notion of using counter-powers to limit risk and the importance of dissent within organizations. For instance, the Head of Risk Management at KfW, a German bank, argued for the superiority of having a “central” risk management function, independent of the business units: “The great advantage [of central risk management] is the absence of conict of interest. The central risk management is not driven by the market. We look at the business from a different angle; we are not involved at the personal level.” (quoted by PriceWaterHouseCoopers, 2007). The purpose of this paper is to study when such virtuous organizational design may fail. We rst propose a model of risk management. Following Augustin Landier et al (forthcoming), we model the trading oor as a simple hierarchy. The role of the trader (T) is to select an asset to invest in, while the risk manager (RM) can decide to approve, or not. Due to his

This paper provides a simple and empirically plausible model of artworks as investment vehicles. It reconciles the observation that average financial returns for collectibles are low and volatile with the theory of consumption-based asset pricing. Art assets are appealing both for their ability to transfer consumption over time and for their use as signals of wealth, as in the literature on the demand for luxuries. Adding art value to utility, returns also reflect this “conspicuous consumption” dividend; as a result, average financial returns are low. Risk premia for artworks are predicted to be modest or even negative.

We study peer effects in the workplace. Specifically, we investigate whether, how, and why the productivity of a worker depends on the productivity of coworkers in the same team. Using high-frequency data on worker productivity from a large supermarket chain, we find strong evidence of positive productivity spillovers from the introduction of highly productive personnel into a shift. Worker effort is positively related to the productivity of workers who see him, but not workers who do not see him. Additionally, workers respond more to the presence of coworkers with whom they frequently interact. We conclude that social pressure can partially internalize free-riding externalities that are built into many workplaces.

Many classes of assets are illiquid or nonmarketable in that they cannot always be traded immediately. Thus, a portfolio position in these becomes at least temporarily irreversible. We study the asset-pricing implications of this type of illiquidity in an exchange economy with heterogeneous agents. In this market, one asset is always liquid. The other asset can be traded initially, but then not again until after a “blackout” period. Illiquidity has a dramatic effect. Agents abandon diversification and choose polarized portfolios instead. The value of liquidity can represent a large portion of the equilibrium price of an asset.

The article discusses and analyzes data from several economic experiments in a household survey with mothers of preschool children. The researchers measured competitiveness by giving the subjects the choice between competing in a tournament or receiving a piece rate for a real effort task. The subjects also participated in lottery choices, which enabled the researchers to assess their risk preferences. The relationship between social preferences and competitiveness in the sample of mothers of preschool children was analyzed. The hypothesis that egalitarian subjects aren't as likely to self-select into competitive environments, which can produce winners and losers, was tested. A negative relationship between egalitarian choices and self-selection into competition was found.