Knowledge that Transforms

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

A large research program in economics has established a persuasive link between institutions and economic development. But what does this imply for development policymaking? Can a political leader or aid agency seeking to promote development readily change institutions? This article starts off wildly general, and then moves to specifics.

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)

In many environments expertise is costly.Costs can manifest themselves in numerous ways, ranging from the time that is required for a nancial consultant to study companies' performances, to the resources necessary for academic referees to produce knowledgeable reports, to the attention and thought needed for jurors to construct informed convictions.The current paper asks a natural question germane to such contexts: how should a committee of potential experts be designed, in terms of the number of participants, their a-priori preferences, as well as the rules by which their recommendations are aggregated into a collective policy?We consider a model in which a principal makes a binary decision (e.g., continue or abort a project), the value of which depends on the realization of some underlying state that is unknown (say, whether the project is great or inferior).The principal can hire a committee of experts from a pool varying in their preferences.All experts have access to an information technology providing (public) information regarding the underlying state.Information comes at a private cost to the experts, who care both about the nal decision the principal takes, as well as about the amount they had personally spent on information acquisition.Concentrating on small committees comprised of up to two potential experts, we provide several layers of responses to our fundamental design question, varying in the exibility of the available contracts.First, we study institutions in which agents make their decisions regarding information acquisition simultaneously and characterize the optimal way to organize committees consisting of either one or two agents.

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)