Knowledge that Transforms

What has driven trade booms and trade busts in the past century and a half? Was it changes in global output or in the costs of international trade? To address this question, we derive a micro-founded measure of aggregate bilateral trade costs based on a standard model of trade in differentiated goods. These trade costs gauge the difference between observed bilateral trade and frictionless trade in terms of an implied markup on retail prices of foreign goods. Thus, we are able to estimate the combined magnitude of tariffs, transportation costs, and all other macroeconomic frictions that impede interna tional trade but that are inherently difficult to observe. We use this measure to examine the growth of global trade between 1870 and 1913, its retreat from 1921 to 1939, and its subsequent rise from 1950 to 2000. We find that trade cost declines explain roughly 55 percent of the pre– World War I trade boom and 33 percent of the post–World War II trade boom, while a precipi tous rise in trade costs explains the entire inter

Hatfield and Milgrom (2005) present a unified model of matching with contracts phrased in terms of hospitals and doctors, which subsumes the standard two-sided matching and some package auction models. They show that a stable allocation exists if contracts are substitutes for each hospital. They further claim that if a hospital's preferences violate the substitutes condition, there exist singleton preferences for the other hospitals and doctors such that no stable allocation exists. We show this last claim does not hold in general. We further present a weaker condition that is necessary to guarantee the existence of stable allocations. (JEL C78, D86, J41)

We analyze a model of trading under incomplete information similar to Chakraborty and Yilmaz (2004a, 2004b). We show that the possible presence of an informed insider in the market with long-lived private information generates an incentive for the insider to bluff or manipulate, i.e., undertake unprofitable trades early on in order to undertake profitable future trades at more favorable prices. In contrast to previous work, where the insider bluffs in order to add noise to the market’s problem of inferring the fundamentals from the observed order flow, in the present paper the insider has an added incentive to manipulate. This arises from the presence of a large number of competitive rational traders who hold coarser information than the insider but finer information than the market maker, making it in their interest to “follow ” the insider’s trades in equilibrium. JEL classification: D82; G12.

Treatment Effect Bounds under Monotonicity Assumptions: An Application to Swan-Ganz Catheterization by Jay Bhattacharya, Azeem M. Shaikh and Edward Vytlacil. Published in volume 98, issue 2, pages 351-56 of American Economic Review, May 2008

I develop a model of bilateral conversations in which players honestly exchange ideas with their competitors. The key to incentive compatibility is complementarity in the information structure: a player can generate a new insight only if he has access to his counterpart's previous thoughts on a topic. I then examine a social network in which A has a conversation with B, then B has a conversation with C, and so on. Relatively underdeveloped ideas can travel long distances over the network. More valuable ideas, by contrast, tend to remain localized among small groups of agents. (JEL D83)

The combination of power utility and i.i.d. lognormal consumption growth makes for a benchmark model in which asset prices and expected returns can be found in closed form. Introducing the consumption-based model, John H. Cochrane (2005, 12) writes, “The combination of lognormal distributions and power utility is one of the basic tricks to getting analytical solutions in this kind of model.” A message of this paper is that the lognormality assumption can be relaxed without sacrificing tractability. Working under two assumptions—that there is a representative agent with power utility and that consumption growth is i.i.d.—I introduce, in Section I, a mathematical object (the cumulantgenerating function, or CGF) in terms of which four fundamental quantities that are at the heart of consumption-based asset pricing can be simply expressed. Those quantities are the equity premium, riskless rate, consumption-wealth ratio, and mean consumption growth. The expressions derived relate the fundamentals directly to the cumulants (equivalently, moments) of consumption growth. The lognormal assumption is equivalent to the assumption that all cumulants above the second are zero. If one is in the business of making up stochastic processes, many suggest themselves most naturally in continuous time. Although there is an obvious discrete-time analogue of Brownian motion—a random walk with Normally distributed increments—it is less natural to map Poisson processes, say, into discrete time, and therefore harder to deal with the possibility of jumps in consumption. In Section II, I show that these results carry over to the continuous-time setting. The i.i.d. growth assumption is replaced by its continuous-time analogue: log consumption is a Levy process. Disasters and the Welfare Cost of Uncertainty

This paper examines the dynamics of violence in the Palestinian-Israeli conflict during the Second Intifada. Using data on the daily number of fatalities between September 2000 and January 2005, we estimate reaction functions for both Israelis and Palestinians and find evidence of Granger causality from Palestinian to Israeli violence, but not vice versa. This finding is consistent using either the incidence or level of fatalities and is robust to the specification of the lag structure and the level of time aggregation. We find no evidence that the Palestinians and Israelis are engaged in a predictable “tit-for-tat” cycle of violence. (JEL D74, H56, O17)

I develop a model of daily labor supply where preferences are dependent on a reference daily income level, and I apply this model to data on the labor supply of New York City taxi drivers. I find that there may be a reference level of income on a given day that affects labor supply. However, there is substantial day-to-day variation in a given driver's reference level, and most shifts end before reaching the reference income level. This pattern is inconsistent with an important role for reference-dependent preferences. (JEL J22, L92)

Preference Heterogeneity and Insurance Markets: Explaining a Puzzle of Insurance by David M. Cutler, Amy Finkelstein and Kathleen McGarry. Published in volume 98, issue 2, pages 157-62 of American Economic Review, May 2008

I study the transmission of collective memory as a mechanism for cultural transmission, in the presence of social externalities associated with individual cultural investment decisions. The younger generation's decisions depend on beliefs about the quality of existing institutions, norms, and values, which are influenced by collective memory. In culturally homogeneous societies it can be optimal to suppress negative memories while emphasizing positive ones. However, the ability to bias collective memory is costly: it may generate cultural overoptimism and overinvestment in some cases, the reverse in other cases. The scope for welfare-enhancing manipulation of collective memory is reduced, moreover, in culturally heterogeneous societies. (JEL D83, Z13)