Knowledge that Transforms

03 We show how comparisons between the within-twin correlations of human capital outcomes across identical and nonidentical twins can be used to identify the variability in the individual-specific component of endowments and the responsiveness of schooling to individual-specific endowments in the family and in the marriage market even when schooling is measured with error. Estimates from two twins samples indicate that 27 (42) percent of the variance in log earnings (obesity) is due to variability in individual-specific endowments, allocations of schooling reinforce specific endowments, and individual-specific earnings endowments of men and their wives' schooling are negatively associated.

This paper explores the dynamics of state taxes and spending during the late 1980s, when regional economic downturns and increased expenditure demands led to substantial state budget deficits. More restrictive state fiscal institutions, such as "no-deficit-carryover" rules and tax and expenditure limitations, are correlated with more rapid fiscal adjustment to unexpected deficits. Political factors are also important. When a single party controls the state house and the governorship, deficit adjustment is much faster than when party control is divided. In gubernatorial election years, tax increases and spending cuts are both significantly smaller than at other times.

This paper develops the quantitative implications of optimal fiscal policy in a business cycle model. In a stationary equilibrium, the ex ante tax rate on capital income is approximately zero. There is an equivalence class of ex post capital income tax rates and bond policies that support a given allocation. Within this class, the optimal ex post capital tax rates can range from close to independently and identically distributed to close to a random walk. The tax rate on labor income fluctuates very little and inherits the persistence properties of the exogenous shocks; thus there is no presumption that optimal labor tax rates follow a random walk. Most of the welfare gains realized by switching from a tax system like that of the United States to the Ramsey system come from an initial period of high taxation on capital income.

This paper examines the change in trading costs for firms that choose to move from a dealer market to a specialist system. Using transactions data, our empirical results reveal structurally induced average trading cost reductions of 4.7 (5.2) cents per share for firms that moved from the NASDAQ/NMS to the NYSE (AMEX) in 1990. For NYSE listed stocks, the trading cost reductions are equally divided between quote improvements and the routing of trades to the NYSE. Trading cost improvements vary inversely with trade sizes and positively with dollar spreads. Finally, the greatest liquidity benefits from listing accrue to the less liquid stocks. Journal of Economic Literature Classification Numbers: D40, G12, G20.

We examine the lead–lag relation between intraday spot and futures prices for a stock index where the component stocks are floor traded while the futures contract is screen traded. We find that futures prices lead spot prices by nearly 20 min. This is much longer than in markets where both the index and index futures are floor traded. We show that this lead–lag relation is unlikely to be an artifact of differences in liquidity between the spot and futures markets. These results are consistent with the hypothesis that screen trading accelerates the price discovery process. Journal of Economic Literature Classification Numbers: F33, G15, G20, O31.

A model is presented in which firms optimally finance investment with both public and private debt. The two instruments are perfect substitutes, except that private debt can easily be renegotiated in insolvency states while public debt cannot. The option to renegotiate is beneficial ex post, as it allows the firm to avoid inefficient liquidation, but ex ante it may worsen asset substitution. The welfare effects of alternative bankruptcy regimes are then compared, taking into account that firms modify their financing decision in response to the regime change. Some suggestions for reforming Chapter 11 of the U.S. bankruptcy code are presented. Journal of Economic Literature Classification Numbers: G32, G33, K2.

This paper analyzes a simple mobility-based model of mortgage lending and uses the results to illuminate the issue of mortgage points. The model predicts the points/interest-rate trade-off observed in the market, and it also predicts that mobile borrowers choose low-points/high-rate contracts from the available menu, in conformance with conventional wisdom. These outcomes are shown to be a result of adverse selection, which arises because of the lender′s inability to distinguish the mobility characteristics of borrowers. Empirical evidence is also presented showing the presence of a points/interest-rate trade-off in the market. In addition, relying on a proxy variable, the results establish that borrowers choose contracts from this menu according to mobility. Journal of Economic Literature Classification Numbers: G21.

Projects with negative expected value cannot obtain financing in competitive capital markets if all potential investors are risk neutral and have identical beliefs about the distribution of the project′s net revenue. We present a series of examples with heterogeneous beliefs in which it is possible for a project to obtain financing even though all investors in the project believe, conditional on the project being undertaken, that the project has negative expected value. An important feature of the examples is that the differences in beliefs are due only to differences in information, and are not simply arbitrary unexplained differences in opinions. Journal of Economic Literature Classification Numbers:D8, G1.

This paper studies the use of cash and credit for making transactions when there is asymmetric information in credit markets. For relatively low inflation rates, equilibria are of the pooling variety and low-credit-risk consumers signal their riskiness to lenders only indirectly by establishing a good track record in credit markets. For higher inflation rates there may exist a separating equilibrium in which low-credit-risk consumers directly signal their type to lenders by specializing in cash early in life and specializing in credit later in life. The greater the degree of adverse selection in credit markets, the wider the range of inflation rates for which a separating equilibrium exists. Credit usage is increasing in the inflation rate, but greater adverse selection may increase or decrease credit usage depending on the parameterization. Journal of Economic Literature Classification Number: E44.