Working Papers

We analyse a model in which bank deposits are insured and there is an exogenous cost of bank capital. The former effect results in bank overinvestment and the latter in underinvestment. Regulatory capital requirements introduce investment distortions which are a constrained optimal response to these market imperfections. We show that capital requirements which are constrained optimal for national banks result in underinvestment by multinational banks. The extent of underinvestment depends upon the home bank`s riskiness, the extent of international diversification, and the liability structure (branch or subsidiary) of the multinational. Capital requirements for international banks should therefore reflect these effects. We relate our findings to observed features of multinational banks and we discuss the possible existence of a multinational bank channel for financial contagion.

JEL Codes: G21, G28

Keywords: Capital adequacy requirements; deposit insurance; multinati

Reference: 2003-FE-11

Authors: Sujoy Mukerji, Jean-Marc Tallon, EUREQua, CNRS - Universite Paris I.

Jul 2003

This paper surveys some economic applications of the decision theoretic framework pioneered by David Schmeidler. We have organized the discussion around three themes: financial markets, contractual arrangements and game theory. The first section discusses papers that have contributed to a better understanding of financial market outcomes based on ambiguity aversion. The second section focusses on contractual arrangements and is divided into two sub-sections. The first sub-section reports research on optimal risk sharing arrangements, while in the second sub-section, discusses research on incentive contracts. The third section concentrates on strategic interaction and reviews several papers that have extended different game theoretic solution concepts to settings with ambiguity averse players. A final section deals with several contributions that are linked only at a formal level, in terms of the pure mathematical structures involved, with Schmeidler`s models of decision making under ambiguity. The contributions involve issues such as, inequality measurement, intertemporal decision making and multi-attribute choice.

JEL Codes: D81

Keywords: Ellsberg Paradox, ambiguity aversion, uncertainty aversion.

Reference: 165

Authors: Mark Rogers

Jul 2003

The rapid rise in schooling in developing countries in recent decades has been dramatic. However, many cross-country regression analyses of the impact of schooling on economic growth find low and insignificant coefficients. This empirical `puzzle` contrasts with theoretical arguments that schooling, through raising human capital, should raise income levels. This paper argues that poor resulst are to be expected when regression samples include countries that vary greatly in their ability to use schooling productively. Data on corruption, the black market premium on foreign exchange and the extent of the brain drain for developing countries are used as indicators of an economy`s productive use of schooling. Regression analysis shows that the impact of secondary schooling on economic growth is substantially higher in countries that are adjudged to use schooling productivity.

JEL Codes: I21, O15, O40

Keywords: Schooling, human capital, corruption, brain drain, economic growth

Reference: 166

Individual View

Authors: John Knight,Linda Yueh, Linda Y. Yueh

Jun 2003

The large-scale reform of the state-owned sector and the development of a private sector in the 1990s changed the nature of employment in urban China. The system of allocated, lifelong jobs (the iron rice bowl) that had previously prevailed under state planning was eroded, permitting more labour turnover and mobility. The degree of mobility of urban workers in China appears not to have been researched, no doubt because there was so little until recently. Using an urban household survey for 1999 that has rich data on job duration, job change and the reasons for it, we provide a first analysis of inter-firm mobility in the urban labour market, its evolution and its explanation. A distinction is made between the, institutionally favoured, urban residents and the rural-urban migrants. The mobility rate of migrants greatly exceeds that of urban residents. For both groups the extent, patterns, determinants and consequences of mobility are explored.

Authors: Katsushi Imai, Pasquale Scandizzo, University of Rome Tor Vergata Raghav Gaiha, University of Delhi

Jun 2003

Consistent with the theory of real options, it is argued that the value of the Employment Guarantee Scheme (EGS) in the Indian state of Maharashtra and its impact on workers` behaviour do not depend so much on its income supplementation as on enlargement of opportunities in an uncertain environment of the local labour market. The choice between the EGS and other activities in rural areas is modelled in a dynamic optimisation framework that takes into account a fixed wage rate and certainty of employment under the former and a stochastic wage rate in the latter. Besides, entry and exit costs of various employment options are taken into account. Finally, allowance is made for volatility of regular labour market activities (e.g. agricultural wage earnings). The predictions of this model are validated with the help of a panel household survey in a semi-arid region of south India. If this analysis has any validity, the incentive case for rural public works schemes such as the EGS in terms of screening and deterrent arguments, premised on a fixed wage rate differential, needs to be reformulated.

JEL Codes: D3, D8, H5, I3, J2

Keywords: options, uncertainty, entry and exit costs, incentives

Reference: 164

Individual View

Authors: Neil Shephard, Enrique Sentana, Gabriele Fiorentini

Jun 2003

GARCH models are commonly used as latent processes in econometrics, financial economics and macroeconomics. Yet no exact likelihood analysis of these models has been provided so far. In this paper we outline the issues and suggest a Markov chain Monte Carlo algorithm which allows the calculation of a classical estimator via the simulated EM algorithm or a Bayesian solution in O(T) computational operations, where T denotes the sample size. We assess the performance of our proposed algorithm in the context of both artificial examples and an empirical application to 26 UK sectorial stock returns, and compare it to existing approximate solutions. GARCH models are commonly used as latent processes in econometrics, financial economics and macroeconomics.

Keywords: Bayesian inference, Dynamic Heteroskedasticity, Factor models, Markov chain

Reference: 2004-FE-02

Authors: Cameron Hepburn

May 2003

This paper shows that the use of hyperbolic discounting in environmental regulation can have unfortunate consequences. In a three-period model we demonstrate that a planner who `naively` employs hyperbolic discounting and fails to anticipate problems of dynamic inconsistency, can oversee a collapse of a renewable resource. If the regeneration rate of the resource is within a given range, and stock levels are close to the `minimum viable population`, then an unforeseen collapse will result. This basic result is shown to hold in an infinite-horizon, continuous-time model with hyperbolic discounting of the sort examined in Barro (1999) and Li and Lofgren (2001). Here, the naive planner does not anticipate extinction of its resource stock because it always plans to lower consumption (but it never does). Two conclusions follow from these results. First, the model provides an explanation for resource collapses such as that of the Peruvian anchovy and Atlantic cod. Second, governments should think carefully before they employ hyperbolic discounting in policymaking.

JEL Codes: Q21, Q28, E61

Keywords: hyperbolic discounting, time-inconsistency, renewable resources

Reference: 159

Individual View

Authors: Katsushi Imai, Raghav Gaiha, University of Delhi

May 2003

Millennium development goal (MDG) of poverty reduction aims for halving of the head-count ratio over the period 1990-2015. Available studies draw attention to the gap between observed and required growth rates, the difficulties of sustaining the latter over time, and whether the policy stance of a government makes a difference to its overall performance. Trade-offs between growth and redistribution in achieving the MDG have also been examined. The present study builds on earlier work in several respects. A two-stage procedure is developed in which income per capita depends on agricultural GDP, a measure of openness of the economy, and regional characteristics in the first stage, and poverty depends on the (estimated) income per capita, a measure of income inequality, and regional characteristics in the second stage. Alternative estimation techniques - including a panel data method- have been employed to check the robustness of the results. The feasibility of halving poverty is examined at the global, regional and country levels. The gaps between required and observed growth rates of aggregate and agricultural income, and the trade-offs between growth and redistribution of income are assessed. While doubts persist about the feasibility of halving poverty in some regions, the results bring into sharper relief the potential of redistribution in achieving this goal.

JEL Codes: I32, O57, R11

Keywords: poverty, goals, growth, redistribution, openness, feasibility

Reference: 161

Individual View

Authors: James Malcomson

May 2003

This paper has been superseded by paper No.221.

Reference: 162

Authors: Gavin Cameron, Chris Wallace

May 2003

Recently, business-university collaborations have become the subject of much interest. It is important to distinguish between `blue-sky` research and more directly commercially applicable research. This paper provides a framework in which to think about the latter. A simple screening model is proposed to study the ways in which a university might sell its research to the private sector. It demonstrates that `technology clubs`, where firms pay a fixed fee to join and a relatively low marginal cost for each piece of research, would increase the amount of research commercially developed and would be beneficial to all parties.

JEL Codes: O3, L3

Keywords: business-university collaboration, screening, technology clubs

Reference: 157

Individual View

Authors: Edward Calthrop

May 2003

Proposals are often made to tax goods which are environmentally damaging. Many such goods are consumed both directly by households and industry at large: for example, carbon-intensive fuel, waste water or congested road space. This paper adopts a tax-reform setting to evaluate such a policy. The welfare impact is shown to depend on an input-substitution effect and an output effect on final consumption, where the latter effect can be conveniently analysed via the standard concept of the marginal welfare cost of a commodity tax. Finally, it is shown that raising a production tax is welfare enhancing if the current tax is below marginal external cost and revenues are recycled via the commodity tax with the highest marginal welfare cost.

JEL Codes: H23, D61

Keywords: externality taxes, productive efficiency, tax reform

Reference: 158

Individual View

Authors: Marcus Alexander, Matthew C. Harding, Department of Economics, MIT

Apr 2003

The trend towards Internet self-regulation is driven both by governments that feel reluctant to invest in direct regulation (because of freedom of speech concerns or high costs of monitoring and enforcement) and by the industry that is under the threat of rising public concerns over content (protection of minors, hate speech, e-business confidence). Our first model explores how firms voluntarily commit themselves to industry-wide or global codes of conduct and reporting initiatives. Then we analyze certification mechanisms through which firms can credibly signal their commitment to self-regulation schemes in the absence of government enforced regulatory standards and use the theoretical results to analyze the logic of current decision making in this area at the European level. Throughout, we illustrate these concepts with a large number of global examples and more detailed European level studies.

JEL Codes: D18, D43, D84, I11, L15, L31

Keywords: self-regulation, certification, healthcare, internet, imperfect competition, credence goods

Reference: 154

Individual View

Authors: Daniel John Zizzo

Apr 2003

This paper presents the results of an experiment where an unequal wealth distribution was created and then subjects could act to change this wealth distribution. Subjects received money by betting and possibly by arbitrary (undeserved) gifts; they could then pay to reduce, redistribute and, in half of the sessions, steal money from others. The experimental results are incompatible with some standard models of interdependent preferences. Over 80% of redistributors were rank egalitarian, but how subjects perceived the problem significantly affected their redistribution activity: perceptions of fairness were not simply a matter of relative payoff, and changed according to whether a subject was undeservedly advantaged or otherwise.

JEL Codes: C72, C91

Keywords: interdependent preferences, altruism, envy, procedural fairness, deservingness, categorization

Reference: 155

Individual View

Authors: Linus Wilson

Apr 2003

Several papers have argued that firms can hide profits from unions with hard debt commitments. Alternatively, here we argue that unions can manipulate the non-shirking constraint and win higher efficiency wages. By creating a culture of mistrust and an opposition to supervision ex ante, unions can ensure higher wages ex post. This resistance to monitoring, nevertheless, leads to deadweight losses. In the absence of debt, it is shown that a sufficiently strong union will opt to minimise monitoring costs because the non-shirking constraint will no longer bind.

JEL Codes: G32, J41

Keywords: efficiency wages, unions, commitment, bonds

Reference: 156

Authors: Colin Mayer, Oren Sussman

Apr 2003

This paper reports a new test of capital structure theories. It uses a filtering technique to identify large investment spikes. We find that the spikes are predominantly financed with debt by large firms and with new equity by small firms. In the process of financing large projects, firms move significantly away from their previous capital structure, as predicted by the pecking order theory. Furthermore, consistent with the pecking order theory, new equity issues are primarily associated with small, loss-making firms. However, we also observe a tendency for firms to adjust back to previous levels of leverage, consistent with a trade-off theory. We conclude that a combination of the pecking order and trade-off theories provides a good description of short-run and longer run dynamics.

JEL Codes: G32

Keywords: capital structure, corporate finance, pecking order theory, trade-off theory

Reference: 2003-FE-16

Authors: Valpy Fitzgerald, Derya Krolzig

Apr 2003

This paper addresses the problem of estimating the aggregate international demand schedule for emerging market (EM) securities as an asset class. The standard ‘push-pull’ model of capital flows is modified by reference to recent work on portfolio choice in the context of credit rationing leading to a simultaneous equation model that determines EM yield and capital flows together. Interaction effects include lagged flows and yields to reflect herding and asset bubbles, with a time-varying risk aversion variable affecting yields and flows. This model is then tested on monthly data for US bond purchases, using the General-to-Specific Approach (GETS) to find significant variables, lags, and shock dummies for yield spread and bond flows separately; followed by a Full Information Maximum Likelihood (FIML) estimation of the two equations together. The results are robust and give a very good fit for both yields and flows, contributing a valuable insight into the dominant impact of short-term shifts in the demand schedule on emerging markets.

JEL Codes: F21, F32, F33, G15, O19

Keywords: asset demand, international finance, capital flows, emerging markets, financial stability

Reference: 2003-FE-10

Authors: Daniel John Zizzo

Mar 2003

Game harmony is a generic game property that can be used to predict cooperation in both generic and well-known normal form games. It describes how harmonious (non-conflictual) or disharmonious (conflictual) the interests of players are, as embodied in the payoffs. Pure coordination games are games of complete harmony, and constant-sum games of pure disharmony: the majority of games is somewhere in the middle. This paper provides measures of game harmony, analyzes their properties and reviews their use as predictors of cooperation in games. Framing effects increasing cooperation may work by increasing perceived game harmony.

JEL Codes: C72, H41

Keywords: cooperation, game harmony, normal form games, framing effects

Reference: 150

Individual View

Authors: Daniel John Zizzo

Mar 2003

The experiment presented in this paper employs 3 x 3 games to analyze how perception of a game affects behavior in the presence or absence of a minimal framing effect and of uncertainty about the values of some game payoffs. We vary the harmony of practice stage games, and explain how this changes later behavior. We employ techniques, such as payoff integration and similarity evaluations, that could be used in further research to open the black box of framing effects. Game harmony is a measure summarizing how harmonious the interests of the players are in the game. It is associated with cooperation.

JEL Codes: C72, C91, D83

Keywords: 3 x 3 games, game harmony, cooperation, cognitive game theory

Reference: 152

Individual View

Authors: Robert Dryburgh

Mar 2003

Overseers’ vested interests played an important role in shaping local poor relief provision under the Old Poor Law. In the industrial town of Bolton the Relief Order books for the 1820s reveal an unusual emphasis upon the payment of paupers’ rent by the parish. This policy was partly a result of self-interest. Many members of the Relief Committee owned substantial quantities of residential property. Such rent payments ensured that these landlords received a subsidy from other ratepayers. A desire to preserve this type of relief, frowned upon by the 1834 Report, may be a contributory factor in the Board of Guardian’s later resistance to the Poor Law Amendment Act.

Reference: 050

Individual View

Authors: Grazia Rapisarda, Eleonora Patacchini, University of Southampton

Mar 2003

Credit subsidies in targeted industrial sectors or geographical areas are a primary mechanism of industrial and redistributive policy throughout the world. Using a unique panel of bank-firm relationships, we study the impact of interest-rate subsidies on the total amount of borrowing and on the average cost of borrowing for subsidised firms. Even though they seem to promote the rise of new bank firm relationships, subsidies have a relatively small effect on the total amount of borrowing when granted to existing clients. We also find evidence of a spillover effect of subsidies on non-subsidised interest rates, which is suggestive of possible rent-seeking activities undertaken by banks and their targeted borrowers. The size of the subsidy, the bank`s local market power, her informational advantage and the length of the bank-client relationship are found to be important determinants of the spillover effect.

JEL Codes: H25, G21, D82, C23

Keywords: funding gaps, credit subsidies, relationship lending, dynamic panel data models

Reference: 153

Individual View

Authors: Oliver Board

Mar 2003

This paper starts with a re-examination of Piccione and Rubinstein`s Absent-Minded Driver problem, and suggests a novel interpretation of Aumann, Hart and Perry`s notion of action-optimality. We then consider several variants of the original problem in which the assumption that the player`s information sets partition the set of his decision nodes is relaxed. This relaxation enables us to construct a counter-example to Piccione and Rubinstein`s result that planning-optimal strategies are always action-optimal. We also show that an agent with more information may do worse than an agent with less.

JEL Codes: C72, D81

Keywords: absentmindedness, action optimality

Reference: 147

Individual View

Authors: Oliver Board

Mar 2003

We construct a dynamic epistemic model for extensive form games, which generates a hierarchy of beliefs for each player over her opponents` strategies and beliefs, and tells us how those beliefs will be revised as the game proceeds. We use the model to analyze the implications of the assumption that the players possess common (true) belief in rationality, thus extending the concept of rationalizability to extensive form games.

JEL Codes: C72, D82

Keywords: rationalizability, extensive form games, belief revision

Reference: 148

Individual View

Authors: Katsushi Imai

Mar 2003

This paper investigates the dynamic aspects of poverty and anti-poverty interventions, particularly focusing on promotional effects, i.e., the effects of helping the poor escape poverty and protective effects, i.e., the effects of preventing the non-poor from slipping into poverty. We test the effectiveness of the Employment Guarantee Scheme (EGS) in rural India as a social safety net drawing upon the ICRISAT survey data. We have carried out the econometric analysis, namely Cox Proportional Hazard Model to estimate the probability of entering or exiting poverty by various covariates drawing upon annual household panel data during the period 1979 to 1984. The following three conclusions have been derived by our estimation results. Firstly, the results suggest that the EGS has significant promotional and protective roles irrespective of the choice of income poverty lines. This is an important finding in the sense that (1) the EGS was effective in reducing poverty in the long run since poverty reduction is achieved through positive promotional and protective roles and (2) the EGS served as insurance for an annual income shortfall. Secondly, we have identified other important factors which prevent households from entering poverty and help them escape poverty, such as decrease in illness of household members, land and access to formal and informal borrowings. Thirdly, we have found that the static determinants of poverty identified by the probit model and `the cause` of poverty estimated by the Cox Model are not much different, implying that static analysis has some implication in identifying the causes of long-term poverty.

JEL Codes: C23, D31

Keywords: South Asia, India, chronic poverty, Employment Guarantee Scheme, safety net

Reference: 149

Individual View

Authors: Katsushi Imai, Per A. Eklund, Agro Resource Systems Group, Sweden,Fabrizio Felloni, International Fund for Agricultural Development, Italy

Feb 2003

This study analyses behaviour of women community based organisations in two districts in Nepal in reducing prevalence of child malnutrition in member households. Our survey focused on three sets of women organisations: those that receive intensive external support are compared with those that receive only moderate assistance, and those that are entirely autonomous, so-called Mothers` Groups. Higher capabilities of the Mothers` Group are found associated with lower underweight. The study also demonstrates that enhanced knowledge diffusion, combined with growth promotion, represents an effective instrument for empowering rural women in acting to reduce prevalence of chronic malnutrition.

JEL Codes: C31, I12, I32, Z13

Keywords: South Asia, Nepal, poverty, child malnutrition, social capital, women`s organisation

Reference: 144

Individual View

Authors: Margaret Stevens, Kathryn Graddy

Feb 2003

In this article, we report the results of an empirical study of the impact of school inputs on pupils` performance in private (independent) schools in the United Kingdom. We use a new school-level panel dataset constructed from information provided by the Independent Schools Information Service (ISIS). We show a consistent negative relationship between the pupil-teacher ratio at a school and the average examination results at that school. Our estimates indicate that the relationship persists even when we are estimating added-value models conditional on previous exam results. The results are noteworthy in comparison with studies for the state sector, relatively few of which have found a consistent and significant effect.

JEL Codes: 12

Keywords: school resources, exam performance, teacher-pupil ratio, private schools

Reference: 146

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