Knowledge that Transforms

We examine how trust is sustained in large societies with random matching, when records of past transgressions are retained for a finite length of time. To incentivize trustworthiness, defaulters should be punished by temporary exclusion. However, it is profitable to trust defaulters who are on the verge of rehabilitation. With perfect bounded information, defaulter exclusion unravels and trust cannot be sustained, in any purifiable equilibrium. A coarse information structure, that pools recent defaulters with those nearing rehabilitation, endogenously generates adverse selection, sustaining punishments. Equilibria where defaulters are trusted with positive probability improve efficiency, by raising the proportion of likely re-offenders in the pool of defaulters.

Historically, European Jews have specialized in financial services while being the victims of antisemitism. We find that the present-day demand for finance is lower in German counties where historical antisemitism was higher, compared to otherwise similar counties. Households in counties with high historical antisemitism have similar saving rates but invest less in stocks, hold lower saving deposits, and are less likely to get a mortgage to finance homeownership after controlling for wealth and a rich set of current and historical covariates. Present-day antisemitism and supply-side forces do not fully explain the results. Households in counties where historical antisemitism was higher distrust the financial sector more—a potential cultural externality of historical antisemitism that reduces wealth accumulation in the long run.

Abstract A series of discontinuities in the allocation mechanism of federal transfers to municipal governments in Brazil allow us to identify the causal effect of public spending on local labour markets, using a “fuzzy” Regression Discontinuity Design (RDD). Our estimates imply a cost per job of about 8,000 US dollars per year and a local income multiplier around two. The effect comes mostly from employment in services and is more pronounced among less financially developed municipalities.

Many decisions are made in environments where outcomes are determined by the realization of multiple random events. A decision maker may be uncertain how these events are related. We identify and experimentally substantiate behaviour that intuitively reflects a lack of confidence in their joint distribution. Our findings suggest a dimension of ambiguity which is different from that in the classical distinction between risk and “Knightian uncertainty”.

Abstract We propose non-parametric definitions of absolute and comparative naivete. These definitions leverage ex ante choice of menu to identify predictions of future behaviour and ex post (random) choices from menus to identify actual behaviour. The main advantage of our definitions is their independence from any assumed functional form for the utility function representing behaviour. An individual is sophisticated if she is indifferent ex ante between retaining the option to choose from a menu ex post or committing to her actual distribution of choices from that menu. She is naive if she prefers the flexibility in the menu, reflecting a mistaken belief that she will act more virtuously than she actually will. We propose two definitions of comparative naivete and explore the restrictions implied by our definitions for several prominent models of time inconsistency.

Abstract A seller has a fixed number of goods to sell by a deadline. At each time, he posts a regular price and decides whether to hold a flash sale. Over time, buyers privately enter the market and strategically time their purchases. If a buyer does not purchase when she arrives, she can pay an attention cost to recheck the regular price afterwards, or she can wait for future flash sales where she may obtain a good at a discounted price. In the unique Markov perfect equilibrium, the seller sporadically holds flash sales to lower the stock of goods. A flash sale increases the willingness to pay of future buyers, but decreases the willingness to pay of buyers who arrive early in the game. When it is very likely that a buyer will obtain a good in a flash sale, the seller holds a “big” initial flash sale for all but one unit of the good.

I present a theory of harmful addiction in which “giving in” to an unwanted urge (i.e. consumption) delays the recurrence of urges in the short-run, but increases their long-run frequency. The theory offers new predictions as to how the frequency, levels, cue-dependence, and temporal consistency of consumption evolve during habituation, while uniquely capturing near-term substitution in demand across time. New welfare implications for restrictions on consumption and on marketing are also addressed.

We measure the impact of direct-to-consumer television advertising (DTCA) by drug manufacturers. Our identification strategy exploits shocks to local advertising markets generated by the political advertising cycle and a regulatory intervention affecting a single product. We find evidence of significant business stealing effects among branded, advertised drugs. In addition, we show positive spillovers from drug advertisements to non-advertised competitors in the same class. We decompose the effect and show it is primarily due to new customers. Finally, we provide evidence that DTCA is cost-effective from a societal standpoint in our setting.

Abstract I study optimal design of a dynamic capital allocation process in an organization in which the division manager with empire-building preferences privately observes the arrival and properties of investment projects, and headquarters can audit projects at a cost. Under certain conditions, a budgeting mechanism with threshold separation of financing is optimal. Headquarters: (1) allocate a spending account to the manager and replenish it over time; (2) set a threshold, such that projects below it are financed from the account, while projects above are financed fully by headquarters upon an audit. Further analysis studies when co-financing of projects is optimal and how the size of the account depends on past performance of projects.

Financial regulation is harmonized across countries even though countries vary in their ability to bail-out their banking sector in the event of a crisis. This article addresses the question of whether countries with different fiscal capacity should optimally have different bank regulation, implemented—among other tools—through capital requirements—a question so far ignored by the theoretical banking literature. I show that countries with larger fiscal capacity should have lower ex ante minimum bank capital requirements, in an environment with endogenously incomplete markets and overinvestment due to “Too-Big-To-Fail” moral hazard and pecuniary externalities. I also show that, in addition to a minimum bank capital requirement, regulators in countries with strong “Too-Big-To-Fail” moral hazard should impose a limit on the liabilities pledged by financial institutions in a crisis state. This implies limits on put options/credit default swap contracts. Finally, I argue that the type of regulatory instrument used is crucial as to whether larger fiscal capacity implies more- or less-stringent bank regulation.