C.V. Starr Research by Topic

C.V. Starr researchers are continually investigating the pressing economic issues of the day using the tools of rigorous empirical and theoretical economic science. Here you will find a large number of academic studies undertaken by C.V. Starr Center research staff, organized by topic.

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Energy Economics | Markets and the Welfare | Financial Crises and Macro-Finance Policy | Institutions and Economic Performance | Wealth distribution, Inequality and Redistributive Policies | Banking Systems, Risk and Financial Markets | Polarization and Conflict | Health and Healthcare | Education and Education Policy | Monetary Policy and Prices | Modern Fiscal Policy | The Economics of Development | Labor Force Dynamics and Household Economics | Unemployment and the Labor Market | Experimental Methods and the Economics of Social Psychology | Housing and the Financial Crisis | International Capital Flows, International Prices, and Trade | Stock Markets and Asset Pricing | Economics of Fluctuations and Dynamics | Migration | Misallocation

Energy Economics

'The Welfare Effects of Nudges: a Case Study of Energy Use Social Comparisons,' Allcott, H. (with J.B. Kessler), 2017.

“Nudge”-style interventions are often deemed “successful” if they cause large behavior change, but they are rarely subjected to full social welfare evaluations. We combine a field experiment with a simple theoretical framework to evaluate the welfare effects of one especially policy-relevant intervention, home energy social comparison reports. In our sample, the reports increase social welfare, although traditional evaluation approaches overstate welfare gains by a factor of 3.7. Overall, the welfare gains from home energy reports might be overstated by $620 million. We develop a prediction algorithm for optimal targeting; this would double the welfare gains.

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'Are Consumers Poorly-Informed about Fuel Economy? Evidence from Two Experiments,' Allcott, H. (with C. Knittel), 2017.

It has long been argued that people are poorly-informed about and inattentive to fuel economy when buying cars, and that this causes us to buy low-fuel economy vehicles despite our own best interest. We test this assertion by running two experiments providing fuel economy information to people shopping for new vehicles. We find zero statistical or economic effect of information on average fuel economy of vehicles purchased. In the context of a simple optimal policy model, the estimates suggest that imperfect information and inattention are not valid as signi cant justi cations for fuel economy standards at current or planned levels.

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'Measuring the Welfare Effects of Residential Energy Efficiency Programs,' Allcott, H. (with M.Greenstone), 2017.

This paper sets out a framework to evaluate the welfare impacts of residential energy efficiency programs in the presence of imperfect information, behavioral biases, and externalities, then estimates key parameters using a 100,000-household eld experiment. Several results run counter to conventional wisdom: we nd no evidence of informational or behavioral failures thought to reduce program participation, there are large unobserved bene ts and costs that traditional evaluations miss, and realized energy savings are only 58 percent of predictions. In the context of the model, the two programs we study reduce social welfare by $0.18 per subsidy dollar spent, both because subsidies are not well-calibrated to estimated externality damages and because of self-selection induced by subsidies that attract households whose participation generates low social value. However, the model predicts that perfectly calibrated subsidies would increase welfare by $2.53 per subsidy dollar, revealing the potential of energy eciency programs.

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'Real-Time Pricing and Electricity Market Design,' Allcott, H., 2013.

This paper considers two related distortions in electricity markets: the lack of real-time retail pricing and the suppression of peak wholesale prices due to Installed Capacity requirements. I lay out a framework for understanding these problems using a two-stage entry model in which producers with multiple technologies set capacity and then sell electricity into wholesale markets as demand varies over time. The model is calibrated to supply and demand conditions in the PJM electricity market. I estimate that moving from 10 percent of consumers on real-time pricing to 20 percent would increase welfare in PJM by $120 million per year. However, the welfare gains from clearer signals of scarcity prices under an Energy Only market design are more than twice as large. Furthermore, equilibrium peak prices in the Energy Only design drop to reasonable levels once a moderate share of retail consumers are on real-time pricing.

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Markets and the Welfare

'The Welfare Effects of Nudges: a Case Study of Energy Use Social Comparisons,' Allcott, H. (with J.B. Kessler), 2017.

“Nudge”-style interventions are often deemed “successful” if they cause large behavior change, but they are rarely subjected to full social welfare evaluations. We combine a field experiment with a simple theoretical framework to evaluate the welfare effects of one especially policy-relevant intervention, home energy social comparison reports. In our sample, the reports increase social welfare, although traditional evaluation approaches overstate welfare gains by a factor of 3.7. Overall, the welfare gains from home energy reports might be overstated by $620 million. We develop a prediction algorithm for optimal targeting; this would double the welfare gains.

download full paper

'Measuring the Welfare Effects of Residential Energy Efficiency Programs,' Allcott, H. (with M.Greenstone), 2017.

This paper sets out a framework to evaluate the welfare impacts of residential energy efficiency programs in the presence of imperfect information, behavioral biases, and externalities, then estimates key parameters using a 100,000-household eld experiment. Several results run counter to conventional wisdom: we nd no evidence of informational or behavioral failures thought to reduce program participation, there are large unobserved bene ts and costs that traditional evaluations miss, and realized energy savings are only 58 percent of predictions. In the context of the model, the two programs we study reduce social welfare by $0.18 per subsidy dollar spent, both because subsidies are not well-calibrated to estimated externality damages and because of self-selection induced by subsidies that attract households whose participation generates low social value. However, the model predicts that perfectly calibrated subsidies would increase welfare by $2.53 per subsidy dollar, revealing the potential of energy eciency programs.

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'Real-Time Pricing and Electricity Market Design,' Allcott, H., 2013.

This paper considers two related distortions in electricity markets: the lack of real-time retail pricing and the suppression of peak wholesale prices due to Installed Capacity requirements. I lay out a framework for understanding these problems using a two-stage entry model in which producers with multiple technologies set capacity and then sell electricity into wholesale markets as demand varies over time. The model is calibrated to supply and demand conditions in the PJM electricity market. I estimate that moving from 10 percent of consumers on real-time pricing to 20 percent would increase welfare in PJM by $120 million per year. However, the welfare gains from clearer signals of scarcity prices under an Energy Only market design are more than twice as large. Furthermore, equilibrium peak prices in the Energy Only design drop to reasonable levels once a moderate share of retail consumers are on real-time pricing.

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'Adverse Selection and Self-fulfilling Business Cycles,' Benhabib, J. (with F. Dong and P. Wang), 2017.

We introduce a simple adverse selection problem arising in credit markets into a standard textbook real business cycle model. There is a continuum of households and a continuum of anonymous producers who produce the final goods from intermediate goods. These producers do not have the resources to make up-front payments to purchase inputs and must do so by borrowing from competitive financial intermediates. However, lending to these producers is risky: honest borrowers will always pay off their debt, but dishonest borrowers will always default. This gives rise to an adverse selection problem for financial intermediaries. In a continuous-time real business cycle setting we show that such adverse selection generates multiple steady states and both local and global indeterminacy, and can give rise to equilibria with probabilistic jumps in credit, consumption, investment and employment driven by Markov sunspots under calibrated parameterizations and fully rational expectations. Introducing reputational effects eliminates defaults and results in a unique but still indeterminate steady state. Finally we generalize the model to firms with heterogeneous and stochastic productivity, and show that indeterminacies and sunspots persist.

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'Advertising, Mass Consumption and Capitalism,' Benhabib, J. and A. Bisin, 2002.

We identified a Postmodernist Critique of the organization of society which suggests that the interaction of monopoly power and advertising creates negative welfare effects for consumers. In particular, advertising takes the form of the “manipulation of preferences,’ leads consumers to “work and spend cycles” and subjects them to the “commodification of leisure.” We studied the interaction of monopoly power and advertising in a simple general equilibrium model, constructed to satisfy the basic postulates of this Critique (especially in terms of the effects of advertising on consumers’ preferences) and we identified specifications and parameter configurations of our model that give rise to equilibria which could support the Postmodernist Critique. Our analysis may provide a framework for the empirical analysis of the relevance of the Critique. In particular, it may be important to assess more precisely the relevance of the component of advertising that is stressed in the Critique, that of the “manipulation of preferences” relative to its informational component. The empirical relevance of the distortion caused by advertising relative to the many distortions and frictions present in the U.S. economy (from incompleteness of financial markets and borrowing constraints, to asymmetric information and distortionary taxation schemes) also remains to be established.

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'A Case for Incomplete Markets,' Cogley, T. and T. Sargent (with L.E. Blume, D.A. Easley, and V. Tsyrennikov), 2015.

We propose a new welfare criterion that allows us to rank alternative financial market structures in the presence of belief heterogeneity. We analyze economies with complete and incomplete financial markets and/or restricted trading possibilities in the form of borrowing limits or transaction costs. We describe circumstances under which variousrestrictions on financial markets are desirable according to our welfare criterion.

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'The Long and the Short of It: Sovereign Debt Crises and Debt Maturity,' Fernandez, R. (with A. Martin), 2015.

We present a simple model of sovereign debt crises in which a country chooses its optimal mix of short and long-term debt contracts subject to standard contracting frictions: the country cannot commit to repay its debts nor to a specific path of future debt issues, and contracts cannot be made state contingent. We show that in order to satisfy incentive compatibility the country must issue short-term debt, which exposes it to roll-over crises and inefficient repayments. We examine two policies — restructuring and reprofiling — and show that both improve ex ante welfare if structured correctly. We show that how debt payments in times of crises is distributed across creditors in immaterial. What matters instead is how the surplus generated by restructuring is divided between the country and its creditors.

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'Frictions in a Competitive, Regulated Market: Evidence from Taxis,' Fréchette, G.R. and A. Lizzeri (with T. Salz), 2016.

This paper presents a dynamic general equilibrium model of a taxi market. The model is estimated using data from New York City yellow cabs. Two salient features by which most taxi markets deviate from the efficient market ideal is the need of both market sides to physically search for trading partners in the product market as well as prevalent regulatory limitations on entry in the capital market. To assess the relevance of these features we use the model to simulate the effect of changes in entry and an alternative search technology. The results are contrasted with a policy that improves the intensive margin of medallion utilization through a transfer of medallions to more efficient ownership. We use the geographical features of New York City to back out unobserved demand through a matching simulation.

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'Yogurt choose consumers? Identification of random utility models via two-sided matching,' Galichon, A. (with O. Bonnet and M. Shum), 2017.

In this paper we describe an equivalence between random utility discretechoice models and two-sided matching models with imperfectly transferable utility, and we exploit its consequences. Based on it, we suggest new approaches for estimation and identification of non-additive random utility models (NARUM), in which the utility shocks do not affect decision-makers’ utilities in an additive manner. The estimation algorithms and procedures we describe are inspired by those in the matching literature. A noteworthy feature of our algorithms is that they yield the point estimate when the model is point identified, and yield the upper and lower bounds on the parameters under partial identification.

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'Middlemen in Limit-Order Markets,' Jovanovic, B. (with A.J. Menkveld), 2015.

A limit order market enables an early seller to trade with a late buyer by leaving a price quote. Information arrival in the interim period creates adverse selection risk for the seller and therefore hampers trade. Entry of high-frequency traders (HFTs) might restore trade as their machines can refresh quotes quickly on (hard) information. Empirically, HFT entry reduced adverse selection by 23% and increased trade by 17%. Model calibration shows that one percentage point more of the gains from trade were realized. Finally, we show that a well-designed double auction raises this to ten percentage points.

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'Trading on Sunspots,' Jovanovic, B. (with V. Tsyrennikov), 2015.

In a model with multiple Pareto-ranked equilibria we endogenize the equilibrium selection probabilities by adding trade in assets that pay based on the realization of a sunspot. Asset trading imposes restrictions on the equilibrium set in a way that raises welfare. When the probability of a low-output outcome is high enough, the coordination game becomes more like a prisoner’s dilemma in which the high-output equilibrium disappears because of the asset positions that agents trade towards induce some agents not to invest. We derive an upper bound on the probabilities of the low-output equilibrium that we interpret as a disaster. We derive asset pricing implications including the disaster premium, and we study the effect on stock prices of news shocks to beliefs.

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'Foreign Ownership of U.S. Safe Assets: Good or Bad?' Ludvigson, S.C. (with J. Favilukis and S. Van Nieuwerburgh), 2016.

The last 20 years have been marked by a sharp rise in international demand for U.S. reserve assets, or safe stores-of-value. What are the welfare consequences to U.S. households of these trends, or of a reversal? In a lifecycle model with aggregate and idiosyncratic risks, the young and oldest households may benefit substantially from such capital inflows, but middle-aged savers may suffer from greater exposure to systematic risk in equity and housing markets. Under the veil of ignorance, a newborn in the lowest wealth quantile is willing to forego 3% of lifetime consumption to avoid a large capital outflow.

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'The Welfare Effects of Intertemporal Price Discrimination: An Empirical Analysis of Airline Pricing in U.S. Monopoly Markets,' Lazarev, J., 2013.

This paper studies how a firm’s ability to price discriminate over time affects production, product quality, and product allocation among consumers. The theoretical model has forward-looking heterogeneous consumers who face a monopoly firm. The firm can affect the quality and quantity of the goods sold each period. I show that in the model the welfare effects of intertemporal price discrimination are ambiguous. I use this model to study the time paths of prices for airline tickets offered on monopoly routes in the U.S. Using estimates of the model’s demand and cost parameters, I compare the welfare travelers receive under the current system to several alternative systems, including one in which free resale of airline tickets is allowed. I find that free resale of airline tickets would increase the average price of tickets bought by leisure travelers by 54% and decrease the number of tickets they buy by 10%. Their consumer surplus would decrease by only 16% due to a more efficient allocation of seats and the opportunity to sell a ticket on a secondary market.

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'Simulating the Dynamic Effects of Horizontal Mergers: U.S. Airlines,' Lazarev, J. (with L. Benkard and A. Bodoh-Creed), 2010.

We propose a new method for studying the medium and long run dynamic effects of horizontal mergers. Our method builds on the two-step estimator of Bajari, Benkard, and Levin (2007). Policy functions are estimated on historical pre-merger data, and then future industry outcomes are simulated both with and without the proposed merger. In our airline entry model, an airline’s entry/exit decisions are made jointly across route segments, and depend on features of its own route network as well as the networks of the other airlines. We also allow for city-specific profitability shocks that affect all route segments out of a given city, as well as segment-specific shocks. Using data for 2003-2008, we apply our model to three recently proposed airline mergers. We find that a merger between two major hub carriers leads to increased entry by the other hub carriers, and can lead to substantial increased entry by low cost carriers, both effects offsetting some of the initial concentrating effects of the merger. Our model also suggests that a merger between two hub carriers can in certain cases lead to dismantling of a hub.

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'Getting More from Less: Understanding Airline Pricing,' Lazarev, J., 2012.

Motivated by pricing practices in the airline industry, the paper studies the incentives of players to publicly and independently limit the sets of actions they can play later in a game. I find that to benefit from self-restraint, players have to exclude all actions that create temptations to deviate and keep some actions that can deter deviations of others. I develop a set of conditions under which these strategies form a subgame perfect equilibrium and show that in a Bertrand oligopoly, firms can mutually gain from self-restraint, while in a Cournot oligopoly they cannot.

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'Matching and Chatting: An Experimental Study of the Impact of Network Communication on School-Matching Mechanisms,' Schotter, A. (with T. Ding), 2016.

While, in theory, the school matching problem is a static non-cooperative one shot game, in reality the “matching game” is played by parents who choose their strategies after consulting or chatting with other parents in their social networks. In this paper we compare the performance of the Boston and the Gale-Shapley mechanisms in the presence of chatting through social networks. Our results indicate that allowing subjects to chat has an important impact on the likelihood that subjects change their strategies and also on the welfare and stability of the outcomes determined by the mechanism.

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Financial Crises and Macro-Finance Policy

'Financial Markets, the Real Economy, and Self-fulfilling Uncertainties,' Benhabib, J. (with X. Liu and P. Wang), 2017.

Uncertainty in both financial markets and the real economy rises sharply during recessions. We develop a model of informational interdependence between financial markets and the real
economy, linking uncertainty to information production (acquisition) and aggregate economic activities to explain this intriguing empirical fact. We argue that there exists mutual learning between financial markets and the real economy. Their joint information productions determine both the real production efficiency in the real sector and the price efficiency in the financial sector. The mutual learning makes information production in the financial sector and that in the real sector a strategic complementarity. A self-fulfilling surge in financial uncertainty and real uncertainty can naturally arise when both sectors produce little information in anticipation
of the other sector to do so. At the same time, aggregate output falls as the real production efficiency deteriorates. Our model has other implications on aggregate economic activities.

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'Illiquidity and Under-Valuation of Firms,' Gale, D. (with P. Gottardi), 2008.

We study a competitive model in which debt-financed firms may default in some states of nature. Incomplete markets prevent firms from hedging the risk of asset firesales when markets are illiquid. This is the only friction in the model and the only cost of default. The anticipation of such losses alone may distort firms’ investment decisions. We characterize the conditions under which competitive equilibria are inefficient and the form the inefficiency takes. We also show that endogenous financial crises may arise as a result of pure sunspot events. Finally, we examine alternative interventions to restore the efficiency of equilibria.

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'Household Leverage and the Recession,' Midrigan, V. (with T. Philippon), 2016.

A salient feature of the Great Recession is that regions that experienced larger declines in household debt also experienced larger declines in employment. We study a model in which liquidity constraints amplify the response of employment to changes in debt. We estimate the model using panel data on consumption, employment, wages and debt for U.S. states. Though successful in matching the cross-sectional evidence, the model predicts that deleveraging cannot, by itself, account for the large drop in aggregate employment in the U.S. The 25% decline in household debt observed in the data leads to a modest 1.5% drop in the natural rate of interest, and is easily offset by monetary policy. Household deleveraging is more potent, however, in the presence of other shocks that trigger the zero lower bound on interest rates. In the presence of such shocks household deleveraging accounts for about half of the decline in U.S. employment.

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'Stress Tests and Bank Portfolio Choice,' Williams, B., 2017.

How informative should bank stress tests be? I use Bayesian persuasion to formalize stress tests and show that regulators can reduce the likelihood of a bank run by performing tests which are only partially informative. Optimal stress tests give just enough failing grades to keep passing grades credible enough to avoid runs. The worse the state of the banking system, the more stringent stress tests must be to prevent runs. I find that optimal stress tests, by reducing the probability of runs, reduce the optimal level of banks’ liquidity cushions. I also examine the impact of anticipated stress tests on banks’ ex ante incentive to invest in risky versus safe assets.

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Institutions and Economic Performance

'Reestablishing the Income-Democracy Nexus,' Benhabib, J. (with A. Corvalan and M. Spiegel), 2011.

A number of recent empirical studies have cast doubt on the “modernization theory” of democratization, which posits that increases in income are conducive to increases in democracy levels. This doubt stems mainly from the fact that while a strong positive correlation exists between income and democracy levels, the relationship disappears when one controls for country fixed effects. This raises the possibility that the correlation in the data reflects a third causal characteristic, such as institutional quality. In this paper, we reexamine the robustness of the income-democracy relationship. We extend the research on this topic in two dimensions: first, we make use of newer income data, which allows for the construction of larger samples with more within-country observations. Second, we concentrate on panel estimation methods that explicitly allow for the fact that the primary measures of democracy are censored with substantial mass at the boundaries, or binary censored variables. Our results show that when one uses both the new income data available and a properly non linear estimator, a statistically significant positive income-democracy relationship is robust to the inclusion of country fixed effects.

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'On the Joint Evolution of Culture and Institutions,' Bisin, A. (with T. Verdier), 2017.

Explanations of economic growth and prosperity commonly identify a unique causal effect, e.g., institutions, culture, human capital, geography. In this paper we provide instead a theoretical modeling of the interaction between culture and institutions and their effects on economic activity. We characterize conditions on the socio-economic environment such that culture and institutions complement (resp. substitute) each other, giving rise to a multiplier effect which amplifies (resp. dampens) their combined ability to spur economic activity. We show how the joint dynamics of culture and institutions may display interesting non-ergodic behavior, hysteresis, oscillations, and comparative dynamics. Finally, in specific example societies, we study how culture and institutions interact to determine the sustainability of extractive societies as well as the formation of civic capital and of legal systems protecting property rights.

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'The Political Economy of Debt and Entitlements,' Lizzeri, A. (with L. Bouton and N. Persico), 2016.

This paper presents a dynamic political-economic model of government obligations. The focus is on the interplay between debt and entitlements. In our model both are tools for temporarily powerful groups to extract resources from groups that will be powerful in the future. Debt transfers resources across periods; entitlements directly target the future allocation of resources. We prove four main results. First, debt and entitlement are (imperfect) substitutes in the sense that constraining debt increases entitlements (and vice versa). Second, if debt is unconstrained, it is beneficial to limit entitlements but not to eliminate them. Third, debt and entitlements respond in opposite ways to political instability, and, in contrast with prior literature, political instability may even reduce debt when entitlements are endogenous. Finally, we identify two possible explanations for the joint growth of debt and entitlements.

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'Price Setting Under Uncertainty About Inflation,' Perez, D. (with A. Drenik), 2017.

We use the manipulation of inflation statistics that occurred in Argentina starting in 2007 to test the relevance of informational frictions in price setting. We estimate that the manipulation of statistics had associated a higher degree of price dispersion. This effect is analyzed in the context of a quantitative general equilibrium model in which firms use information about the inflation rate to set prices. Consistent with empirical evidence, we find that monetary policy becomes more effective with less precise information about inflation. Not reporting accurate measures of the CPI entails significant welfare losses, especially in economies with volatile monetary policy.

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'Equilibrium Effects of Firm Subsidies,' Rotemberg, M. , 2017.

Subsidy programs have two countervailing effects on firms: direct gains for eligible firms and indirect losses for firms whose competitors are eligible. In 2006, India changed the eligibility criteria for small-firm subsidies, and the sales of newly eligible firms grew by roughly 35 percent. Competitors of the newly eligible firms were also affected, with almost complete crowd-out within products that were less internationally traded, but little crowd-out for moretraded products. The newly eligible firms had positive marginal products, so relaxing the eligibility criteria for subsidies increased aggregate productivity. I calibrate the gains to aggregate productivity have been around 1-2%, although targeting different firms could have led to similar gains.

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'Communication and Investment: Evidence from the expansion of postal services,' Rotemberg, M. (with J. Feigenbaum) , 2014.

When acquiring information about potential buyers is costly, sellers will be unable to make the best possible match. We capture the consequences of this in a model where producers make investment decisions anticipating their future response to search costs. When one good has higher information frictions than another, decreasing those frictions increases production of that good along the extensive and intensive margins, and given specialization constraints production of the other good will decrease. Using a novel dataset on the roll-out of free postal delivery in rural communities in the US at the turn of the 20th century, we find evidence in line with the predictions of the model, as investment in manufacturing signicantly increased in counties which got more free delivery routes, while investments in agriculture signicantly decreased.

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'Stress Tests and Bank Portfolio Choice,' Williams, B., 2017.

How informative should bank stress tests be? I use Bayesian persuasion to formalize stress tests and show that regulators can reduce the likelihood of a bank run by performing tests which are only partially informative. Optimal stress tests give just enough failing grades to keep passing grades credible enough to avoid runs. The worse the state of the banking system, the more stringent stress tests must be to prevent runs. I find that optimal stress tests, by reducing the probability of runs, reduce the optimal level of banks’ liquidity cushions. I also examine the impact of anticipated stress tests on banks’ ex ante incentive to invest in risky versus safe assets.

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Wealth distribution, Inequality and Redistributive Policies

'Wealth Distribution and Social Mobility in the US: A Quantitative Approach,' Benhabib, J., A. Bisin, and M. Luo, 2015.

This paper attempts to quantitatively identify the factors that drive wealth dynamics in the U.S. and are consistent with its observed skewed cross-sectional distribution and social mobility. We concentrate on three critical factors: a skewed and persistent distribution of earnings, differential saving and bequest rates across wealth levels, and capital income risk. All of these factors are necessary for matching both distribution and mobility, with a distinct role in inducing wealth accumulation near the borrowing constraints, contributing to the thick top tail of wealth, and affecting upward and/or downward social mobility.

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'Age, Luck and Inheritance,' Benhabib, J. (with S. Zhu), 2009.

We introduce the investment risk into a heterogeneous agents model and present a mechanism to analytically generate a double Pareto distribution of wealth. We replicate the distribution of the U.S. wealth and especially the three prominent features: a high Gini coefficient, skewness to the right, and Pareto tails. We disentangle the contribution of inheritance, age and stochastic rates of capital return to wealth inequality, in particular to the Gini coefficient. Finally, we investigate the effects of the fiscal and redistributive policies on wealth inequality and social welfare.

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'The distribution of wealth: Intergenerational transmission and redistributive policies,' Benhabib, J. and A. Bisin, 2007.

We study the dynamics of the distribution of wealth in an economy with intergenerational transmission of wealth and redistributive fiscal policy. We characterize the transitional dynamics of the distribution of wealth as well as its stationary state. We show that the stationary wealth distribution is a Pareto distribution. We study analytically the dependence of the distribution of wealth, of wealth inequality, and of utilitarian social welfare on various redistributive fiscal policy instruments like capital income taxes, estate taxes, and welfare subsidies.

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'Inequality, redistribution and cultural integration in the Welfare State,' A. Bisin and T. Verdier, 2016.

This paper constructs a simple theoretical political economy model to analyze the dynamic interactions between redistribution, public good provision and cultural integration of minority groups. Cultural differentiation erodes the support for general public good provision and vertical redistribution, reducing in turn the attractiveness of adoption of the mainstream culture by the minority groups. Our model shows the possibility for multiple politico-cultural steady state trajectories depending strongly on the initial degree of cultural differentiation in the society. An exogenous increase in income inequality is shown to increase the likelihood of multiple steady state trajectories. In a context with multiple minority groups, culltural fragmentation favors integration into the mainstream culture.

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'Inequality, Business Cycles and Fiscal-Monetary Policy,' Sargent, T. (with A. Bhandari, D. Evans and M. Golosov), 2017.

We study fluctuations in macroeconomic aggregates and cross-section income and wealth distributions in a heterogeneous agent model with incomplete markets and sticky nominal prices. Optimal fiscal-monetary policy balances gains from ”fiscal hedging” against benefits from redistributional hedging that responds to social concerns about inequality. A Ramsey planner uses inflation to offset inequality-increasing shocks to the cross-section distribution of labor earnings. A calibration that imitates how US recessions reshape that crosssection distribution in ways documented by Guvenen et al. (2014) indicates that substantial welfare benefits come from making inflation respond to aggregate shocks.

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Banking Systems, Risk and Financial Markets

'Equilibrium Corporate Finance and Intermediation,' Bisin, A. (with P. Gottardi, and G. Ruta), 2014.

This paper analyzes a class of competitive economies with production, incomplete financial markets, and agency frictions. Firms take their production, financing, and contractual decisions so as to maximize their value under rational conjectures. We show that competitive equilibria exist and that shareholders always unanimously support firms’ choices. In addition, equilibrium allocations have well-defined welfare properties: they are constrained efficient when information is symmetric, or when agency frictions satisfy certain specific conditions. Furthermore, equilibria may display specialization on the part of identical firms and, when equilibria are constrained inefficient, may exhibit excessive aggregate risk. Financial decisions of the corporate sector are determined at equilibrium and depend not only on the nature of financial frictions but also on the consumers’ demand for risk. Financial intermediation and short sales are naturally accounted for at equilibrium.

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'Windfall Gains and Stock Market Participation,' Cesarini, D. (with J.S Briggs, E. Lindqvist, and R. Östling), 2015.

We estimate the causal effect of wealth on stock market participation using administrative data on Swedish lottery players. A $150,000 windfall gain increases stock ownership probability among pre-lottery non-participants by 12 percentage points, while pre-lottery stock holders are unaffected. The effect is immediate, seemingly permanent and heterogeneous in intuitive ways. Standard lifecycle models predict wealth effects far too large to match our causal estimates under common calibrations. Additional analyses suggest a limited role for explanations such as procrastination or real-estate investment. Overall, results suggest that “nonstandard” beliefs or preferences contribute to the nonparticipation of households across many demographic groups.

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'Sovereign Debt, Domestic Banks, and the Provision of Public Liquidity,' Perez, D., 2015.

This paper explores two mechanisms through which a sovereign default can disrupt the domestic economy via its banking system. First, a default creates a negative balance sheet effect on banks, which prevents the flow of resources to productive investments. Second, default undermines internal liquidity as banks replace government securities with less productive investments. A quantitative analysis of the model shows that these mechanisms generate a deep and persistent fall in output post-default, which accounts for the government’s commitment necessary to explain observed levels of external public debt. The model is used to study policies that address the government’s lack of commitment.

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'Sovereign Debt Maturity Structure Under Asymmetric Information,' Perez, D., 2015.

This paper studies the optimal choice of sovereign debt maturity when investors are unaware of the government’s willingness to repay. Under a pooling equilibrium there is a wedge between the borrower’s true default risk and the default risk priced in debt, and the size of this wedge differs with the maturity of debt. Long-term debt becomes less attractive for safe borrowers since it pools more default risk that is not inherent to them. In response, safe borrowers issue low levels of debt with a shorter maturity profile -relative to the optimal choice under perfect information and risky borrowers mimic the behavior of safe borrowers to preclude the market from identifying their type. In times of financial distress, spreads increase and the default risk wedge of long-term debt relative to short-term debt increases which makes borrowers shorten their debt maturity. Data on bond issuances for a panel of countries show that, consistent with the model, maturities co-vary negatively with spreads and that this co-movement is stronger in those situations in which informational asymmetries are larger.

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'Sets of Models and Prices of Uncertainty,' Sargent, T. (with L.P. Hansen), 2015.

A decision maker constructs a convex set of nonnegative martingales to use as likelihood ratios that represent parametric alternatives to a baseline model and also nonparametric models statistically close to both the baseline model and the parametric alternatives. Max-min expected utility over that set gives rise to equilibrium prices of model uncertainty expressed as worst-case distortions to drifts in a representative investor’s baseline model. We offer quantitative illustrations for baseline models of consumption dynamics that display long-run risk. We describe a set of parametric alternatives that generates countercyclical prices of uncertainty.

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'A Case for Incomplete Markets,' Cogley, T. and T. Sargent (with L.E. Blume, D.A. Easley, and V. Tsyrennikov), 2015.

We propose a new welfare criterion that allows us to rank alternative financial market structures in the presence of belief heterogeneity. We analyze economies with complete and incomplete financial markets and/or restricted trading possibilities in the form of borrowing limits or transaction costs. We describe circumstances under which variousrestrictions on financial markets are desirable according to our welfare criterion.

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'Long Swings in Currency Markets: Imperfect Knowledge and I(2) Trends,' Frydman, R. (with M.D. Goldberg, S. Johansen, and K. Juselius), 2012.

Using multivariate unit-root tests, the paper finds that real and nominal exchange rates are more persistent than univariate unit-root studies suggest. It shows that an imperfect knowledge economics model of currency swings and risk is able to account for this greater persistence, even though it recognizes that market participants revise their forecasting strategies in non-routine ways, and thus, does not impose a fixed probability distribution on how these strategies unfold over time. The model provides the micro-foundations for a persistent segmented trends process, thereby explaining the tendency for asset prices to move in one direction for long stretches of time. The paper shows that if one were prepared to assume away the importance of non-routine revisions of forecasting strategies and impose a Markov chain on such change, the Engel and Hamilton (1990) segmented-trends model of long swings would result.

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'An Empirical Study of Trade Dynamics in the Fed Funds Market,' Lagos, R. (with G. Afonso), 2014.

We use minute-by-minute daily transaction-level payments data to document the cross-sectional and time-series behavior of the estimated prices and quantities negotiated by commercial banks in the fed funds market. We study the frequency and volume of trade, the size distribution of loans, the distribution of bilateral fed funds rates, and the intraday dynamics of the reserve balances held by commercial banks. We find evidence of the importance of the liquidity provision achieved by commercial banks that act as de facto intermediaries of fed funds.

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'Monetary Exchange in Over-the-Counter Markets: A Theory of Speculative Bubbles, the Fed Model, and Self-fulfilling Liquidity Crises,' Lagos, R. (with S. Zhang), 2015.

We develop a model of monetary exchange in over-the-counter markets to study the effects of monetary policy on asset prices and standard measures of financial liquidity, such as bid-ask spreads, trade volume, and the incentives of dealers to supply immediacy, both by participating in the market-making activity and by holding asset inventories on their own account. The theory predicts that asset prices carry a speculative premium that reflects the asset’s marketability and depends on monetary policy as well as the microstructure of the market where it is traded. These liquidity considerations imply a positive correlation between the real yield on stocks and the nominal yield on Treasury bonds—an empirical observation long regarded anomalous. The theory also exhibits rational expectations equilibria with recurring belief driven events that resemble liquidity crises, i.e., times of sharp persistent declines in asset prices, trade volume, and dealer participation in market-making activity, accompanied by large increases in spreads and abnormally long trading delays.

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'Turnover Liquidity and the Transmission of Monetary Policy,' Lagos, R. (with S. Zhang), 2016.

We provide empirical evidence of a novel liquidity-based transmission mechanism through which monetary policy influences asset markets, develop a model of this mechanism, and assess the ability of the quantitative theory to match the evidence.

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'Monetary Policy and Asset Valuation,' Ludvigson, S.C. (with F. Bianchi and M. Lettau), 2017.

This paper presents evidence of infrequent shifts, or ìbreaks,îin the mean of the consumption-wealth variable cay(t) that are strongly associated with low-frequency fluctuations in the real value of the Federal Reserveís primary policy rate, with low policy rates associated with high asset valuations, and vice versa. By contrast, there is no evidence that infrequent shifts to high asset valuations and low policy rates are associated with higher economic growth or lower economic uncertainty; indeed the opposite is true. Additional evidence shows that low interest rate/high asset valuation regimes coincide with significantly lower equity market risk premia.

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'Capital Share Risk and Shareholder Heterogeneity in U.S. Stock Pricing,' Ludvigson, S.C. and S. Ma (with M. Lettau), 2017.

Capital share risk exhibits signiÖcant explanatory power for several cross-sections of expected returns, while subsuming much or all of the explanatory power of predominant returnbased factor models. For most portfolios, positive exposure to capital share risk earns a positive risk premium, commensurate with recent inequality-based asset pricing models. But in a striking and puzzling exception to this Önding, the risk price is strongly negative for momentum. We show that this Önding is central for understanding one key feature of the data, namely the negative correlation between value and momentum strategies, both of which earn high average returns.

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'Foreign Ownership of U.S. Safe Assets: Good or Bad?' Ludvigson, S.C. (with J. Favilukis and S. Van Nieuwerburgh), 2016.

The last 20 years have been marked by a sharp rise in international demand for U.S. reserve assets, or safe stores-of-value. What are the welfare consequences to U.S. households of these trends, or of a reversal? In a lifecycle model with aggregate and idiosyncratic risks, the young and oldest households may benefit substantially from such capital inflows, but middle-aged savers may suffer from greater exposure to systematic risk in equity and housing markets. Under the veil of ignorance, a newborn in the lowest wealth quantile is willing to forego 3% of lifetime consumption to avoid a large capital outflow.

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'Liquidity Constraints in the U.S. Housing Market,' Midrigan, V. (with D. Gorea), 2017.

We study the severity of liquidity constraints in the U.S. housing market using a lifecycle model with uninsurable idiosyncratic risks in which houses are illiquid, but agents have the option to refinance their long-term mortgages or obtain home equity loans. The model reproduces well the distribution of individual-level balance sheets – the fraction of housing, mortgage debt and liquid assets in households’ wealth, the fraction of hand-to-mouth homeowners (Kaplan and Violante, 2014), as well as the frequency of housing turnover and home equity extraction in the 2001 data. The model implies that 75% of homeowners are liquidity constrained and willing to pay an average of 8 cents to extract an additional dollar of liquidity from their home. Liquidity constraints imply sizable welfare losses equivalent to a 1.2% permanent reduction in consumption.

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'Stress Tests and Bank Portfolio Choice,' Williams, B., 2017.

How informative should bank stress tests be? I use Bayesian persuasion to formalize stress tests and show that regulators can reduce the likelihood of a bank run by performing tests which are only partially informative. Optimal stress tests give just enough failing grades to keep passing grades credible enough to avoid runs. The worse the state of the banking system, the more stringent stress tests must be to prevent runs. I find that optimal stress tests, by reducing the probability of runs, reduce the optimal level of banks’ liquidity cushions. I also examine the impact of anticipated stress tests on banks’ ex ante incentive to invest in risky versus safe assets.

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Polarization and Conflict

'Groups in Conflict: Size Matters, But Not in the Way You Think,' Ray, D. (with L. Mayoral), 2016.

This paper studies costly conflict over private and public goods. Oil is an example of the former, political power an example of the latter. Groups involved in conflict are likely to be small when the prize is private, and large when the prize is public. We examine these implications empirically by constructing a global dataset at the ethnic group level and studying conflict along ethnic lines. Our theoretical predictions find significant confirmation in an empirical setting.

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Health and Healthcare

'The Empirical Content of Models with Multiple Equilibria in Economies with Social Interactions,' Bisin, A. (with A. Moro and G. Topa), 2011.

We study a general class of models with social interactions that might display multiple equilibria. We propose an estimation procedure for these models and evaluate its efficiency and computational feasibility relative to different approaches taken to the curse of dimensionality implied by the multiplicity. Using data on smoking among teenagers, we implement the proposed estimation procedure to understand how group interactions affect health-related choices. We and that interaction effects are strong both at the school level and at the smaller friends-network level. Multiplicity of equilibria is pervasive at the estimated parameter values, and equilibrium selection accounts for about 15 percent of the observed smoking behavior. Counterfactuals show that student interactions, surprisingly, reduce smoking by approximately 70 percent with respect to the equilibrium smoking that would occur without interactions.

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'Data-Driven Incentive Alignment in Capitation Schemes,' Chassang, S. (with M. Braverman), 2015.

This paper explores whether Big Data, taking the form of extensive but high dimensional records, can reduce the cost of adverse selection in government-run capitation schemes. We argue that using data to improve the ex ante precision of capitation regressions is unlikely to be helpful. Even if types become essentially observable, the high dimensionality of covariates makes it infeasible to precisely estimate the cost of serving a given type. This gives an informed private provider scope to select types that are relatively cheap to serve. Instead, we argue that data can be used to align incentives by forming unbiased and non-manipulable ex post estimates of a private provider’s gains from selection.

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Education and Education Policy

'Education and Borrowing Constraints: An Analysis of Alternative Allocation Systems,' Fernandez, R., 2008.

This paper compares the allocative properties of markets and exams in an environment in which students differ in wealth and ability and schools differ in quality. In the presence of borrowing constraints, exams are shown to dominate markets in terms of matching efficiency. Whether aggregate consumption is greater under exams than under markets depends on the power of the exam technology; for a sufficiently powerful test, exams dominate markets in terms of aggregate consumption as well. The effects of income taxation are analyzed and the optimal allocation scheme when wealth is observable is derived. The latter consists of allowing markets to set school prices but having the government allocate fellowships based both on financial need and exam score.

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'Learning and Mechanism Design: An Experimental Test of School Matching Mechanisms with Intergenerational Advice,' Schotter, A. (with T. Ding), 2015.

The results of this paper should be taken as a cautionary tale by mechanism designers. While the mechanisms that economists design are typically in the form of static one-shot games, in the real world mechanisms are used repeatedly by generations of agents who engage in the mechanism for a short period of time and then pass on advice to their successors. Hence, behavior evolves via social learning and may diverge dramatically from that envisioned by the designer. We demonstrate that this is true of school matching mechanisms, even those, like the Gale-Shapley Deferred-Acceptance mechanism where truth-telling is a dominant strategy.

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'Matching and Chatting: An Experimental Study of the Impact of Network Communication on School-Matching Mechanisms,' Schotter, A. (with T. Ding), 2016.

While, in theory, the school matching problem is a static non-cooperative one shot game, in reality the “matching game” is played by parents who choose their strategies after consulting or chatting with other parents in their social networks. In this paper we compare the performance of the Boston and the Gale-Shapley mechanisms in the presence of chatting through social networks. Our results indicate that allowing subjects to chat has an important impact on the likelihood that subjects change their strategies and also on the welfare and stability of the outcomes determined by the mechanism.

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'Genes, Education, and Labor Market Outcomes: Evidence from the Health and Retirement Study,' Thom, K. (with N.W. Papageorge), 2016.

Recent advances have led to the discovery of specific genetic variants that predict educational attainment. We study how these variants, summarized as a genetic score variable, are associated with human capital accumulation and labor market outcomes in the Health and Retirement Study (HRS). We demonstrate that the same genetic score that predicts education is also associated with higher wages, but only among individuals with a college education. Moreover, the genetic gradient in wages has grown in more recent birth cohorts, consistent with interactions between technological change and labor market ability. We also show that individuals who grew up in economically disadvantaged households are less likely to go to college when compared to individuals with the same genetic score, but from higher-SES households. Our findings provide support for the idea that childhood SES is an important moderator of the economic returns to genetic endowments. Moreover, the finding that childhood poverty limits the educational attainment of high-ability individuals suggests the existence of unrealized human potential.

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'Genetic Ability, Wealth, and Financial Decision-Making,' Thom, K. (with D. Bath, and N.W. Papageorge), 2017.

Recent advances in behavioral genetics have enabled the discovery of genetic scores linked to a variety of economic outcomes, including education. We build on this progress to demonstrate that the same genetic variants that predict educational attainment independently predict household wealth in the Health and Retirement Study (HRS). This relationship is partly explained by higher earnings, but a substantial portion of this association cannot be explained mechanically by income flows or bequests. This leads us to explore the role of beliefs, financial literacy and portfolio decisions in explaining this genetic gradient in wealth. We show that individuals with lower genetic scores are more prone to reporting “extreme beliefs” (e.g., reporting that there is a 100% chance of a stock market decline in the near future) and they invest their savings accordingly (e.g., avoiding the stock market). Our findings suggest that genetic factors that promote human capital accumulation contribute to wealth disparities not only through education and higher earnings, but also through their impact on the ability to process information and make good financial decisions. The association between genetic ability and wealth is substantially lower among households receiving a defined benefit pension. Policies that transfer greater responsibility to individuals to manage their wealth might therefore exacerbate the consequences of labor market inequality.

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