Knowledge that Transforms

This paper develops the stochastic theory of distribution with a dynamic model which focuses on the role of incomplete insurance in generating inequality. Unlike previous work, our approach takes explicit account of the reason for market incompleteness in modeling agents' behaviour; in particular, the amount of risk borne is endogenous. Using a model of growth with altruism in which agents are risk-averse and there is moral hazard, we show that lineage wealth follows a Markov process which converges globally to an ergodic distribution; this also represents the long-run population distribution of wealth. We discuss the role of particular assumptions, such as availability of production loans and unboundedness of utility, in yielding the qualitative properties of the distribution of wealth, the choice of “occupation” and the prevention of poverty traps.

The main result of this paper is to characterize the class of two-person social choice correspondences which are Nash-implementable. The characterization result is used to formulate domain restrictions which allow the construction of non-dictatorial and Pareto-efficient social choice correspondences which are Nash-implementable.

The Kullback-Leibler information criterion is used as a basis for one-sided testing of nested hypothesis. No distributional form is assumed, so nonparametric density estimation is used to form that test statistic. In order to obtain a normal null limiting distribution, a form of weighting is employed. The test is also shown to be consistent against a class of alternatives. The exposition focuses on testing for serial independence in time series, with a small application to testing the random walk hypothesis for exchange rate series, and tests of some other hypotheses of econometric interest are briefly described.

Efficiency is analyzed in a Walrasian model of labor markets with adverse selection. Workers are distinguished by productivity and preferences; firms are distinguished by productivity and ability to distinguish workers. An equilibrium is defined to be constrained efficient if it cannot be dominated by an incomplete mechanism. The set of equilibria turns out to have an interesting structure. Within the class of strongly monotonic economies, there exists at least one efficient equilibrium. Under slightly stronger conditions, an equilibrium is dominated by an incomplete mechanism only if it can be dominated by another equilibrium, that is, equilibria are Pareto optimal.

An optimal contract design problem is considered. Contracts which are incomplete and simple are used to investigate the extent to which constrained revisions can mitigate inefficiencies resulting from contractual incompleteness. An optimal contract is characterized in two cases. First, when a contract is being used to facilitate trade between two risk-neutral parties who must make relationship-specific investments, it is possible to implement the first-best by a simple contract. Second, when a contract is being used to share risk, it is generally not possible to implement the first-best.

This paper offers a model of intermediation in the Diamond-Dybvig tradition in which both fiat currency and bank deposits are present. The behavior of the economy's price level, deposit-currency ratio, and money supply is compared across equilibria in which bank runs do and do not occur. It is shown that the behavior of these variables in the presence and absence of runs is consistent with that observed in the United States during the period from 1929 to 1933.

When the managers of a firm are not its owners, agency problems result if managers take actions that maximize their own utility rather than the value of the firm. This paper investigates the existence of agency problems in mutual savings and loans. Using a more general approach than in previous studies, I show that mutual S&Ls were operating with an inefficient output mix while stock S&Ls were not, suggesting an agency problem among mutual S&Ls. The results cast doubt on a common argument that mutuals convert to stock S&Ls to capture economies of scale.

This paper investigates how the market reaction to debt and equity offers is influenced by investors' expectations as to the type of security to be issued. We find a significantly positive 1% announcement day return for debt issues made by firms that would normally be expected to issue equity. In contrast, the market reacts negatively when firms that are expected to issue debt issue equity instead. These results suggest that the informational content of public security offerings is conditioned by investors' prior beliefs. Further, our results also support the prediction of asymmetric information theory that debt issues convey good news relative to equity issues.

This paper analyzes the role of financial intermediaries as marketmakers in the market for interest rate swaps. We argue that intermediaries which hold large nontraded portfolios of swaps are efficient alternatives to direct hedging by counterparties in publicly traded cash and futures instruments. The efficiency afforded by the swap marketmaker derives from reduction in transactions costs, diversification of basis risk, and reduced agency costs of debt. The analysis provides an explanation for the existence and success of the swaps market as a means for spreading risk and for its dominance by large financial institutions.

The traditional structure-conduct-performance (SCP) hypothesis relates concentration and the mean level of prices but ignores the dispersion of prices around their mean levels. This paper tests two hypotheses which are capable of explaining both the mean and the dispersion of elements in the pricing vector of retail banks—a concentration/collusion-based hypothesis and an asymmetric information-based hypothesis. Evidence is found that the dispersion of bank fees across banks may be due to both market structure and information reasons. The level of bank fees appears to be generally insignificantly related to concentration.