Knowledge that Transforms

Households with familiarity biases tilt their portfolios toward a few risky assets. The resulting mean-variance loss from portfolio underdiversification is equivalent to only a modest reduction of about 1 percent per year in a household’s portfolio return. However, once we consider also the effect of familiarity biases on the asset- allocation and intertemporal consumption-savings decisions, the welfare loss is multiplied by a factor of four. In general equilibrium, the suboptimal decisions of households distort also aggregate growth, amplifying further the overall social welfare loss. Our findings demonstrate that financial markets are not a mere sideshow to the real economy and that improving the financial decisions of households can lead to large benefits, not just for individual households, but also for society. (JEL D14, D91, E21, E44, G11, G41)

This paper investigates the role of self-fulfilling expectations in sovereign bond markets. We consider a model of sovereign borrowing featuring endogenous debt maturity, risk-averse lenders, and self-fulfilling crises à la Cole and Kehoe (2000). In this environment, interest rate spreads are driven by both fundamental and nonfundamental risk. These two sources of risk have contrasting implications for the maturity structure of debt chosen by the government. Therefore, they can be indirectly inferred by tracking the evolution of debt maturity. We fit the model to Italian data and find that nonfundamental risk played a limited role during the 2008–2012 crisis. (JEL E43, E44, F34, G01, G15, H63)

Making a transfer in kind reduces its value to recipients but can improve targeting. We develop an approach to quantifying this tradeoff and apply it to home care. Using randomized experiments by Medicaid, we find that in-kind provision significantly reduces the value of the transfer to recipients while targeting a small fraction of the eligible population that is sicker and has fewer informal care-givers than the average eligible. Under a wide range of assumptions within a standard model, the targeting benefit exceeds the distortion cost. This highlights an important cost of recent reforms toward more flexible benefits. (JEL D82, H51, H75, I18, I38)

Human capital differences across countries can appear large or small depending on measurement methods. This Reply clarifies key assumptions and conceptual distinctions across accounting approaches. Accounting-based arguments for small human capital differences are difficult to sustain. By contrast, large human capital differences are theoretically and empirically coherent. Non-accounting arguments against large human capital variation are examined and their weaknesses pinpointed. This Reply also suggests a fruitful way forward for this literature, providing a natural conception of human capital that integrates literatures on ideas and institutions with the accounting of Jones (2014). (JEL E24, I26, J24, J31)

We revisit the revenue comparison of standard auction formats, including first-price, second-price, and English auctions. We rank auctions according to their revenue guarantees, i.e., the greatest lower bound of revenue across all informational environments, where we hold fixed the distribution of bidders’ values. We conclude that if we restrict attention to the symmetric affiliated models of Milgrom and Weber (1982) and monotonic pure-strategy equilibria, first-price, second-price, and English auctions are revenue guarantee equivalent: they have the same revenue guarantee, which is equal to that of the first-price auction as characterized by Bergemann, Brooks, and Morris (2017). If we consider all equilibria or if we allow more general models of information, then first-price auctions have a greater revenue guarantee than all other auctions considered. (JEL D44, D83)

We study the market for ratings agencies in the commercial mortgage backed securities sector leading up to and including the financial crisis of 2007–2008. Using a structural model adapted from the auctions literature, we characterize the incentives of ratings agencies to distort ratings in favor of issuers. We find an important equilibrium distortion, which decreased after the crisis. We study several counterfactual experiments motivated by recent policymaking in this industry. (JEL D44, G01, G24)

I study expertise acquisition in a model of trading under asymmetric information. I propose and implement a method to measure r, the ratio of the marginal social value to the marginal private value of expertise. This can be decomposed into three sufficient statistics: traders’ average profits, the fraction of bad assets among traded assets, and the elasticity of good assets traded with respect to capital inflows. I measure r = 0.16 for the junk bond underwriting market. Since this is less than 1, it implies that marginal investments in expertise destroy surplus. (JEL D82, G11, G14, G21, L84)

I characterize the optimal financial regulation policy in an economy where financial intermediaries trade capital assets on behalf of households, but must retain an equity stake to align incentives. Financial regulation is necessary because intermediaries cannot be excluded from privately trading in capital markets. They don’t internalize that high asset prices force everyone to bear more risk. The socially optimal allocation can be implemented with a tax on asset holdings. I derive a sufficient statistic for the externality and use market data on leverage and volatility of intermediaries’ equity to measure it. (JEL D82, G01, G12, G20, G31, H25)

We address how using different censoring thresholds and imputation procedures affects the baseline results of Coibion, Gorodnichenko, and Hong (2015). Higher censoring thresholds introduce measure ment error and outliers that generate wide variability in results across weighting schemes, but methods that explicitly control for outliers confirm the results of Coibion, Gorodnichenko, and Hong (2015) for all censoring thresholds. We also illustrate how the BLS’s approach to imputing missing prices can introduce a cyclical bias into measures of posted price inflation when store-switching is present in the data. (JEL D12, E31, E32, L25, L81)

International trade collapsed, and also became much less multilateral, during the 1930s. Previous studies, looking at aggregate trade flows, have argued that trade policies had relatively little to do with either phenomenon. Using a new dataset incorporating highly disaggregated information on the United Kingdom’s imports and trade policies, we find that while conventional wisdom is correct regarding the impact of trade policy on the total value of British imports, discriminatory trade policies can explain the majority of Britain’s shift toward Imperial imports in the 1930s. (JEL F13, F14, F54, N74)