Working Papers

Authors: David Hendry

Jan 2016

Abstract:

Macroeconomic time-series data are aggregated, inaccurate, non-stationary, collinear and rarely match theoretical concepts. Macroeconomic theories are incomplete, incorrect and changeable: location shifts invalidate the law of iterated expectations and ‘rational expectations’ are then systematically biased. Empirical macro-econometric models are non-constant and mis-specified in numerous ways, so economic policy often has unexpected effects, and macroeconomic forecasts go awry. In place of using just one of the four main methods of deciding between alternative models, theory, empirical evidence, policy relevance and forecasting, we propose nesting ‘theory-driven’ and ‘datadriven’ approaches, where theory-models’ parameter estimates are unaffected by selection despite searching over rival candidate variables, longer lags, functional forms, and breaks.

JEL Codes: C51, C22

Keywords: Model Selection, Theory Retention, Location Shifts, Indicator Saturation, Autometrics.

Reference: 778

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Authors: H Peyton Young, Lucas Merrill Brown

Jan 2016

Abstract:

We study the increasing use of stock options to compensate executives in US corporations. As with many technological innovations, the adoption curve exhibits a classic S-shaped pattern: the rate rises slowly at first, then there is a period of rapid acceleration, and finally it tails off as the saturation level is approached. Using a longitudinal data set of Frydman and Saks (2010) supplemented with financial reports compiled by the authors, we argue that the diffusion of options was initially given a jump-start by a change in the tax law, but thereafter it was propelled by a process in which firms learned from the experience of earlier adopters. The notion that options spread primarily through social conformity or ‘jumping on the bandwagon’ is not borne out by the data.

JEL Codes: O33,O35

Reference: 777

Authors: Jasper van Dijk

Jan 2016

Abstract:

This paper shows that attracting tradable jobs to a city has a bigger positive impact on employment in the non-tradable sector in the same city when the unemployment rate is higher. Therefore it is efficient to stimulate firms in the tradable sector to locate and/or expand in cities with relatively high unemployment rate. This policy would also reduce disparity between cities. Finally the jobs created in the non-tradable sector due to this local multiplier effect from the tradable sector will employ relatively more current inhabitants in cities with a high unemployment rate, thus making this policy more attractive for local policy makers as well.

A simple model illustrates the effect of a demand shock on employment in the non-tradable sector of a city. Empirically I consider the effect of demand from workers in the tradable sector on employment in the non-tradable sector in the same city using U.S. census data from 1980 to 2000. I find that 100 additional jobs in the tradable sector will increase employment in the non-tradable sector in the same city by employing 81 current residents and employing 28 workers that move to the city from other regions. I find that the size of this local employment multiplier depends on the local unemployment rate. Specifically, the multiplier for current residents increases, which drives the overall effect, but the multiplier for migrants decreases.

JEL Codes: F16, R15, R23

Keywords: Local labour market, Multiplier, Tradable, Non-tradable, Unemployment, Migration

Reference: 776

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Authors: Peter Neary, Dermot Leahy

Dec 2015

Abstract:

We compare trade liberalization under Cournot and Bertrand competition in reciprocal markets. In both cases, the critical level of trade costs below which the possibility
of trade affects the domestic firm's behavior is the same; trade liberalization increases trade volume monotonically; and welfare follows a U-shaped pattern. However, welfare
is usually greater under Bertrand than Cournot competition, despite the fact that for higher trade costs the volume of trade is greater under Cournot competition. In general,
there exists a “Nimzowitsch Region” in parameter space, where welfare is higher under Bertrand competition even though no actual trade takes place.

JEL Codes: F12,F13

Keywords: Cournot and Bertrand Competition, Cross-Hauling, Nimzowitsch Region,Oligopoly and Trade,Trade Liberalization

Reference: 775

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Authors: Peter Neary, Monika MrázováMathieu Parenti

Dec 2015

Abstract

We derive exact conditions relating the distributions of firm productivity, sales, output, and markups to the form of demand; in particular, for a large family (including Pareto, log-normal, and Fréchet), the distributions of productivity and output are the same if and only if demand is "CREMR" (Constant Revenue Elasticity of Marginal Revenue). Moreover, we use the Kullback-Leibler Divergence to quantify the information loss when a predicted distribution fails to match the actual one; and we find that,to explain the sales distribution, the choice between Pareto and log-normal productivity distributions matters less than the choice between CREMR and other demands.

JEL Codes: F15, F23, F12

Keywords: CREMR Demands; Heterogeneous Firms; Kullback-Leibler Divergence; Log-Normal Distribution; Pareto Distribution.

Reference: 774

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Authors: Rozana Himaz

Dec 2015

Abstract:

This paper investigates empirically whether large expenditure cuts and revenue rises that were the result of deliberate political efforts towards being austere had an impact on electoral outcomes in the UK using data from 1900 to 2015. The main electoral outcomes considered are the change in ruling party ideology and the margin of victory faced by the incumbent at the general election, in terms of seats secured. The paper finds that large cuts in spending and large rises in revenue significantly increases the chance of a government changing. However, the loss in seats were significantly higher for the incumbent compared to the winning partly only when large spending cuts were pursued rather than revenue increases during the incumbent's tenure in office. We also find that voters are sensitive to particular types of spending cuts, such as cuts in social security. These results are contrary to those in Alesina et.al (2013) using OECD data for 19 countries from 1975-2008, and several other papers in the empirical literature that found no significant correlation between fiscal adjustment and electoral looses.

 

JEL Codes: H2, H3, H5

Keywords: Fiscal austerity, electoral outcomes, United Kingdom

Reference: 773

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Authors: Ferdinand Rauch, Adriana Kocornik-Mina, Thomas K.J. McDermott, Guy Michaelsor

Dec 2015

Abstract

Does economic activity relocate away from areas that are at high risk of recurring shocks? We examine this question in the context of floods, which are among the costliest and most common natural disasters. Over the past thirty years, floods worldwide killed more than 500,000 people and displaced over 650,000,000 people. This paper analyzes the effect of large scale floods, which displaced at least 100,000 people each, in over 1,800 cities in 40 countries, from 2003-2008. We conduct our analysis using spatially detailed inundation maps and night lights data spanning the globe's urban areas. We find that low elevation areas are about 3-4 times more likely to be hit by large floods than other areas, and yet they concentrate more economic activity per square kilometre. When cities are hit by large floods, the low elevation areas also sustain more damage, but like the rest of the flooded cities they recover rapidly, and economic activity does not move to safer areas. Only in more recently populated urban areas, flooded areas show a larger and more persistent decline in economic activity. Our findings have important policy implications for aid, development and urban planning in a world with rising urbanization and sea levels.

JEL Codes: R11, Q54

Keywords: Urbanization, Flooding, Climate change, Urban recovery

Reference: 772

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Authors: Jasper van Dijk

Dec 2015

Abstract

This paper replicates Moretti (AER, 2010). I estimate the local employment multiplier between the tradable and the nontradable sector in MSAs in the United States using two methods. The first replicates Moretti's results, based on the description he gives in his paper and part of his estimation files. I am able to reverse engineer the specification he uses, but identify some discrepancies with his results. The second method is an alternative to his specification that produces more robust estimates of the local multiplier effect with more policy relevance. Using an alternative instrument which, I argue is more plausibly exogenous, I find that for each 100 new jobs in the tradable sector, there are 84 additional jobs created in the nontradable sector of the same city. This is 75 fewer jobs than predicted by Moretti.

JEL Codes: F16, R15, R23

Keywords: Local labor market, multiplier, tradable, nontradable

Reference: 771

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Authors: Andrew Mell

Dec 2015

Abstract:

A rational long lived player plays against a series of short lived players who use a variant of the Adaptive Play behavioral rule. In equilibrium, under certain conditions, there will be a cut-off level of reputation. If their reputation is below the cut-off, they will build their reputation, and consume out of their reputation if it is above the cut-off. Over the long run, their reputation oscillates around the cut-off. A public relations professional can manipulate the sampling of the short lived players to the benefit of the long lived player. As a result a patient long lived player's behavior will worsen while an impatient long lived player's behavior will improve.

JEL Codes: D82,D83,D84

Keywords: Reputation, Adaptive Play, Monitoring, Expectation Formation

Reference: 770

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Authors: Peter Neary

Dec 2015

Abstract

This paper presents a new model of oligopoly in general equilibrium and explores its implications for positive and normative aspects of international trade. Assuming
“continuum-Pollak" preferences, the model allows for consistent aggregation over a continuum of sectors, in each of which a small number of home and foreign firms engage in
Cournot competition. I show how competitive advantage interacts with comparative advantage to determine resource allocation, and, specializing to continuum-quadratic
preferences, I explore the model's implications for the gains from trade, for the distribution of income between wages and profits, and for production and trade patterns in
a two-country world.

JEL Codes: F10, F12

Keywords: “Continuum-Pollak" preferences, Continuum-quadratic preferences, GOLE (General Oligopolistic Equilibrium),Market integration,Trade and income distribution

Reference: 769

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Authors: Beata Javorcik,Peter Neary, Carsten Eckel, Leonardo Iacovone

Dec 2015

Abstract:

We review the implications of the "core competence" model of multi-product firms, including the “market-size paradox”: for most countries, the world market is much larger than the home market, while the costs of accessing foreign markets are relatively low; hence the model predicts that most domestic firms should export more of their core products than they sell domestically; yet, in practice, we do not observe this. Extending the model to allow for investment in export market penetration resolves the puzzle, and Mexican data confirm its predictions: in particular,only the largest firms exhibit the dominance of exports over home sales.

JEL Codes: F12

Keywords: Core competence model, Export market penetration costs, Flexible manufacturing, Multi-product firms.

Reference: 768

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Authors: Kevin Hjortshøj O'Rourke

Dec 2015

Abstract:

The paper looks at the development of the secular stagnation thesis, in the context of the economic history of the time. It explores some 19th century antecedents of the thesis, before turning to its interwar development. Not only Alvin Hansen, but Keynes and Hicks were involved in the conversations that led to Hansen's eventual statement of the thesis that we are familiar with. The argument made sense in the context of the interwar period, but more so in Britain than the US.

Keywords: Secular stagnation, Alvin Hansen, Keynes, Economic history, History of economic thought, Interwar

Reference: 139

Individual View

Authors: Alan Beggs

Nov 2015

Abstract

This paper studies learning when agents evaluate outcomes in comparison to a reference point. It shows that certain models of reinforcement learning lead to
classes of recursive preferences.

JEL Codes: D830, D870

Keywords: Reference points, Reinforcement Learning, Recursive Preferences

Reference: 767

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Authors: Peiran Jiao

Nov 2015

This paper applies survival analysis to individual trading data from a discount brokerage firm, and documents significant individual-level repurchase bias, investors' tendency to disproportionately repurchase more previously sold winners than losers. Investor sophistication and experience mitigated the bias, but generated asymmetric effects: the most sophisticated/experienced investors' tendency to avoid prior losers were almost completely eliminated, but they were still over twice more likely to repurchase prior winners. Limited attention, chasing past performance and risk-adjusted returns could not justify the asymmetry. This suggests one reason for loss from frequent trading was persistent naive reinforcement learning in repurchasing prior winners.

JEL Codes: D10,D14,G10

Keywords: Repurchase Bias, Reinforcement Learning, Sophistication, Experience.

Reference: 765

Individual View

Authors: Peiran Jiao

Nov 2015

Abstract:

Investors in the financial markets typically have access to both descriptive information of assets, from brochures, financial analysts, reports, etc., and own experience.
However, little is known about the role of experience in investment decisions. This paper investigates this issue by experimentally testing the effects of experience in an
investment task with choice feedback and varying levels of descriptive information. We document the double-channeled effects of experience: when elicited beliefs were controlled
for, participants significantly relied on experience regardless of the descriptions, behaving consistently with the law of effect; additionally, beliefs were also distorted by experience, in that participants were more optimistic about assets from which they gained, and pessimistic about previously unowned assets. In a calibration exercise, reinforcement learning significantly added predictive power to expected utility models.

JEL Codes: C91, D03, D83, G11.

Keywords: Description, Experience, Investment Decision, Belief Distortion.

Reference: 766

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Authors: , Paul Glasserman, Peyton Young

Nov 2015

JEL Codes: G01,D85

Reference: 764

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Authors: Guido Ascari, Louis Phaneuf, Eric Sims

Nov 2015

Abstract

We offer a comprehensive evaluation of the welfare and cyclical implications of moderate trend inflation. In an extended version of a medium-scale New Keynesian model, recent proposals to increase trend inflation from 2 to 4 percent would generate a consumption-equivalent welfare loss of 3.7 percent based on the non-stochastic steady state and of 6.9 percent based on the stochastic mean. Welfare costs of this magnitude are driven by four main factors: i) multiperiod nominal wage contracting, ii) trend growth in investment-specific and neutral technology, iii) roundaboutness in the U.S. production structure, and iv) and the interaction between trend inflation and shocks to the marginal efficiency of investment (MEI), insofar that this type of shock is sufficiently persistent. Moreover, moderate trend inflation has important cyclical implications. It interacts much more strongly with MEI shocks than with either productivity or monetary shocks.

JEL Codes: E31,E32

Keywords: Wage and price contracting; trend inflation; trend growth in technology; roundabout production; investment shocks; inflation costs; business cycles.

Reference: 763

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Authors: James Wolter

Oct 2015

Abstract

We propose a hazard model where dependence between events is achieved by assuming dependence between covariates. This model allows for correlated variables specific to observations as well as macro variables which all observations share. This setup better fits many economic and financial applications where events are not independent. Nonparametric estimation of the hazard function is then studied. Kernel estimators proposed in Nielsen and Linton (1995, Annals of Statistics) and Linton, Nielsen and Van de Geer (2003, Annals
of Statistics) are shown to have similar asymptotic properties compared with the i.i.d.case. Mixing conditions ensure the asymptotic results follow. These results depend on adjustments to bandwidth conditions. Simulations are conducted which verify the impact of dependence
on estimators. Bandwidth selection accounting for dependence is shown to improve performance. In an empirical application, trade intensity in high-frequency financial data is estimated.

JEL Codes: C13, C14, C51

Keywords: Hazard estimation, Correlated events, Dependent covariates, Common covariates, Kernel estimation.

Reference: 761

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Authors: James Wolter

Oct 2015

Abstract

This paper derives asymptotics for functionals of a hazard model with an exposure-time effect and time-varying covariates. A semi-nonparametric sieve maximum likelihood estimator of a competing risks model based on the Cox proportional hazard is considered. Consistency of the estimator and its rate of convergence in the Fisher norm are derived. These results are prerequisites for asymptotic normality of plug-in estimators of hazard functionals. This provides an inference procedure for a large class of functionals including the conditional probability of events and various asset pricing formulas for defaultable securities. Asset pricing formulas in this class include the value of mortgages, insurance contracts, bonds, swaps and other options.

JEL Codes: C01, C14, C41

Keywords: Conditional probabilities, Sieve estimation, Hazard models

Reference: 760

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Authors: Alan Beggs

Oct 2015

Abstract

This paper studies the sensitivity of economic equilibria to perturbations when the implicit function theorem cannot be applied on account of the presence of boundaries. It presents results from the mathematical programming literature which provide conditions under which equilibria are robust to perturbation and are locally unique Lipschitz-continuous functions of parameters. Economic applications include search equilibrium, Cournot equilibrium and general equilibrium.

JEL Codes: C61, C62

Keywords: Sensitivity analysis, Implicit function theorem, Equilibria, Variational inequalities, Boundaries

Reference: 762

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Authors: Francesco Zanetti, Masashige Hamano

Oct 2015

Abstract

This paper introduces endogenous products entry and exit based on creation and destruction of product variety in a general equilibrium model. Recessionary technology shocks induce exit of unprofitable products on impact, allocating resources towards more productive production lines. However, during the recovery phase less productive production lines survive destruction, counteracting the original increase in productivity. The analysis shows that recoveries hinge on lower product destruction rather than higher product creation. Endogenous product destruction is critical to evaluate the effect of permanent policies of entry deregulation and subsidies aimed to stimulate the economy.

JEL Codes: D24, E23, E32, L11, L60

Keywords: Firm heterogeneity, endogenous product destruction, business cycles.

Reference: 759

Individual View

Abstract

In China political control is centralised and economic management is decentralised. This gives rise to a serious principal-agent problem, in which the agents are often better informed than the principal. China also has a semi-marketised economy involving much state intervention. This intervention serves both a political and an economic function. It assists the Communist Party to remain in political command and generates formidable patronage resources. It also provides the policy instruments, including incentive structures for officialdom, to maintain a ‘developmental state’. The combination of economic decentralisation and semi-marketised economy creates a problem of weak accountability and a breeding ground for rent seeking and corruption.


For a quarter of a century China’s leadership gave overwhelming priority to the objective of achieving rapid economic growth. This policy was viewed as providing political legitimacy and securing the best protection against social instability. It is argued that the leadership was able to solve the principal-agent problem in its pursuit of economic growth.


By contrast, the solution to the principal-agent problem failed in other respects, giving rise to societal costs. Little attention was paid to the dramatic socioeconomic changes –including rising inequality and economic insecurity, environmental degradation, mass migration, rent seeking and corruption – which accompanied economic growth and posed new challenges. It is argued that these changes help to explain the failure of life satisfaction scores to rise over the two decades 1990-2010. They can also help to explain the rise in indicators of social instability over that period. It is to be hoped that the new leadership’s current anti-corruption campaign together with its declared policy intention to reduce state economic intervention and increase reliance on competitive markets will strengthen deterrence and weaken opportunities for rent seeking and corruption. The paper carries the implication that China’s economy cannot be well understood except through the lens of political economy.

JEL Codes: H10, H70, O53, P16

Keywords: Accountability, China, Developmental state, Governance, Life satisfaction, Political economy, Social instability

Reference: 758

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Authors: Climent Quintana-Domeque, Marco Gonzalez-Navarro

Sep 2015

Abstract

We provide the first experimental estimation of the effects of the supply of publicly financed urban infrastructure on property values. Using random allocation of first-time street asphalting of residential streets located in peripheral neighbourhoods in Mexico, we show that within two years of the intervention households are able to transform their increased property wealth into significantly larger rates of vehicle ownership, household appliances, and home improvements. Increased consumption is made possible via both credit use and less saving. A cost-benefit analysis indicates that the valuation of street asphalting as capitalized into property values is about as large as construction costs.

JEL Codes: C93, H41, O12, O18

Keywords: development, infrastructure, credit use, wealth effect, randomized controlled trial

Reference: 757

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Authors: Mark Armstrong

Sep 2015

Abstract

I survey the use of nonlinear pricing as a method of price discrimination, both with monopoly and oligopoly supply. Topics covered include an analysis of when it is profitable to offer quantity discounts and bundle discounts, connections between second- and third-degree price discrimination, the use of market demand functions to calculate nonlinear tariffs, the impact of consumers with bounded rationality, bundling arrangements between separate sellers, and the choice of prices for upgrades and add-on products.

 

JEL Codes: D11,D21,D42,D86,L13,M31

Keywords: Price discrimination, nonlinear pricing, bundling, product-line pricing, screening, discrete choice.

Reference: 756

Individual View

Authors: Ferdinand Rauch, Shaun Larcom, Tim Willems

Sep 2015

Abstract

We estimate that a significant fraction of commuters on the London underground do not travel their optimal route. Consequently, a tube strike (which forced many commuters to experiment with new routes) taught commuters about the existence of superior journeys -- bringing about lasting changes in behaviour. This effect is stronger for commuters who live in areas where the tube map is more distorted, thereby pointing towards the importance of informational imperfections. We argue that the information produced by the strike improved network-efficiency. Search costs are unlikely to explain the suboptimal behaviour. Instead, individuals seem to under-experiment in normal times, as a result of which constraints can be welfare-improving.

JEL Codes: D83,L91,R41

Keywords: Experimentation, Learning, Optimization, Rationality, Search

Reference: 755

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