Knowledge that Transforms

This paper develops a framework for a general equilibrium analysis of asset markets when the number of assets is infinite. Such markets have been studied in the context of asset pricing theories. Our main results concern the existence of an equilibrium. We show that an equilibrium exists if there is a price system under which no investor has an arbitrage opportunity. A similar result has been previously known to hold in finite asset markets. Our extension to infinite assets involves a concept of an arbitrage opportunity which is different from the one used in finite markets. An arbitrage opportunity in finite asset markets is a portfolio that guarantees non-negative payoff in every event, positive payoff in some event, and has zero price. For the case of infinite asset markets, we introduce a concept of sequential arbitrage opportunity which is a sequence of portfolios which increases an investor's utility indefinitely and has zero price in the limit. We show that a sequential arbitrage opportunity and an arbitrage portfolio are equivalent concepts in finite markets but not in their infinite counterpart.

J. S. Duesenberry's (1949) ratcheting consumption demand is derived as a feature of the optimal dynamic consumption and investment policy given extreme habit formation that prevents consumption from falling over time. Preferences are in effect non-time-separable, extended-real-valued von Neumann-Morgenstern preferences. Consumption increases each time wealth reaches a new maximum. Risky investment is proportional to the excess of wealth over the perpetuity value of current consumption. Extensions constrain the net rate of decrease in consumption with a constant other than zero, add more consumption goods, and constrain on the maximal holding of the risky asset as a proportion of wealth. Copyright 1995 by The Review of Economic Studies Limited.

We examine an endogenous growth model in which market frictions are an integral part of the economic environment. Workers invest in education when young, which raises their productivity once employed. The level of schooling also acts as a key determinant of the rate of economic growth by influencing workers' ability to accumulate additional human capital on-the-job. Once schooling is completed, workers search for employment. The division of the surplus between vacancies and searching workers is characterized, as is the optimal level of education. The economy may display multiple steady-state growth paths.

Externalities between buyers are shown to induce delays in negotiations between a seller and several buyers. Delays arise in a perfect and complete information setting with random matching even when there is no deadline. While with a deadline we identify delays both for positive and negative externalities, without a deadline we find that (1) when externalities are positive, there exists no SPNE in pure strategies with bounded recall that exhibits delay; (2) when externalities are negative, it may happen that all SPNE with bounded recall have the property that long periods of waiting alternate with short periods of activity: This is the cyclical delay phenomenon.

Despite familiar arguments for diversification, many investors choose to hold significant blocks of equity in the same firm. While control benefits may explain majority blocks, most blocks are much smaller than what is generally considered necessary for control. This paper develops a theory whereby such blocks can confer to their holders partial benefits of control; in particular, small block shareholders can join together and form controlling coalitions. The implications of such a cooperative game among block shareholders for the shareholder structure within and across firms are examined. This paper predicts large investors will "create their own space" by staking out large enough blocks to deter other block investors, there will be a threshold level above which large investors are not challenged, and that the shareholder structure across firms will exhibit a particular clientele effect among block shareholders. These predictions are consistent with a preliminary review of empirical evidence.

This paper provides a comprehensive treatment of a basic income maintenance problem for a group of individuals who differ in their income generating abilities. It stresses the impact that imperfect information about such abilities has on programme design. The analysis serves two purposes. First, we are able to unify the theoretical literature on the income maintenance problem. Second, we examine the impact of allowing the government to impose workfare on recipients of income support. In addition to being of policy interest, this is a theoretically challenging problem since it requires solving a multi-dimensional screening problem. The solution that we find is strikingly simple. It separates the poor into two categories, with the lower income groups subject to workfare while facing a 100% marginal tax rate on earnings. The second group does no public work and is offered a benefit schedule which taxes earnings at a lower rate.

In this paper, we study the optimization problem of an unregulated air carrier which is given the exclusive right to satisfy demand for air travel between any pair of cities. It chooses a network of connections and a set of prices to maximize profits. Thus, both network design and prices are endogenous. We characterize the solution to this optimization problem when demands and costs are symmetric. Our main result is that, if there are economies of density in the number of individuals travelling between two directly connected cities, the optimal network is either a hub of size n − 1 or one in which every pair of cities is connected directly.

We study a credit model where, because of adverse selection, unprofitable projects may nevertheless be financed. Indeed they may continue to be financed even when shown to be low-quality if sunk costs have already been incurred. We show that credit decentralization offers a way for creditors to commit not to refinance such projects, thereby discouraging entrepreneurs from undertaking them initially. Thus, decentralization provides financial discipline. Nevertheless, we argue that it puts too high a premium on short-term returns. The model seems pertinent to two issues: “soft budget constraint” problems in centralized economies, and differences between “Anglo-Saxon” and “German-Japanese” financing practices.

We demonstrate how to estimate a model of oligopoly pricing when products are multi-dimensionally differentiated. We provide an empirical counterpart to recent theoretical work on product differentiation. Using specifications informed by economic theory, we estimate price-cost margins for products differentiated in many dimensions.