We study the impact of labor market frictions on asset prices in the cross section. In stock return predictability regressions a 10% increase in the firm’s hiring rate is associated with a decrease of 1.3% to 1.8% in the firm’s annual expected stock return. We propose an investment-based asset pricing model with labor and capital stochastic adjustment costs to explain the negative correlation between hiring and risk premiums. Firms with relatively high hiring rates are expanding firms that face high adjustment costs. If the economy experiences a shock that lowers adjustment costs, these firms will benefit the most from these lower costs, allowing these firms to grow faster and make profits more quickly. The corresponding increase in value of these firms during these times is a hedge against adjustment cost shocks which explains the lower expected returns of these firms in equilibrium. With quasi-fixed labor, the model quantitatively matches the predictability of hiring, key properties of the firm-level hiring and investment rates, and other empirical regularities.
Acemoglu and Johnson (2007) present evidence that improvements in population health do not promote economic growth. We show that their result depends critically on the assumption that initial health has no causal effect on subsequent economic growth. We argue that such an effect is likely, primarily because childhood health affects adult productivity. In our augmented model, which includes initial health, the instrumental variable proposed by Acemoglu and Johnson has no significant predictive power for improvements in health and does not identify the effect of contemporaneous improvements in health on economic growth.
We present a theory of context-dependent choice in which a consumer's attention is drawn to salient attributes of goods, such as quality or price. An attribute is salient for a good when it stands out among the good's attributes, relative to that attribute's average level in the choice set (or more broadly, the choice context). Consumers attach disproportionately high weight to salient attributes and their choices are tilted toward goods with higher quality/price ratios. The model accounts for a variety of disparate evidence, including decoy effects and context-dependent willingness to pay. It also suggests a novel theory of misleading sales.
This paper distinguishes between the human capital and signaling theories by estimating the earnings return to a high school diploma. Unlike most indicators of education (e.g., a year of school), a diploma is essentially a piece of paper hence by itself cannot affect productivity. Any earnings return to holding a diploma must therefore reflect the diploma's signaling value. Using regression discontinuity methods to compare the earnings of workers that barely passed and barely failed high school exit exams–standardized tests that students must pass to earn a high school diploma–we find little evidence of diploma signaling effects.
We develop a theory of capital controls as dynamic terms-of-trade manipulation. We study an infinite horizon endowment economy with two countries. One country chooses taxes on international capital flows in order to maximize the welfare of its representative agent, while the other country is passive. In this neoclassical benchmark model we show that capital controls are not guided by the absolute desire to alter the intertemporal price of the goods produced in any given period, but rather by the relative strength of this desire between two consecutive periods. Specifically, a country growing faster than the rest of the world has incentives to promote domestic savings by taxing capital inflows or subsidizing capital outflows. Although our theory of capital controls emphasizes interest rate manipulation, the pattern of borrowing and lending, per se, is irrelevant.
Stock and Treasury bond comovement, volatilities, and their relations to their price valuations and fundamentals change stochastically over time, both in magnitude and direction. These stochastic changes are explained by a general equilibrium model in which agents learn about composite economic and inflation regimes. We estimate our model using both fundamentals and asset prices, and find that inflation news signals either positive or negative future real economic growth depending on the times, thereby affecting the direction of stock/bond comovement. The learning dynamics generate strong non-linearities between volatilities and price valuations. We find empirical support for numerous predictions of the model.
Diversity-enhancing policies are practiced around the world. This paper explores the economics of such policies. A model is proposed where heterogeneous agents, distinguished by skill level and social identity, purchase productive opportunities (or slots) in a competitive market. The problem of designing an efficient policy to raise the status of a disadvantaged identity group in this competition is considered. We show that: (i) when agent identity is fully visible and contractible, efficient policy grants preferred access to slots, but offers no direct assistance for acquiring skills; and, (ii) when identity is not contractible, efficient policy provides universal subsidies to skill development when the fraction of the disadvantaged group at the skill development margin is larger than their share at the slot assignment margin.
This paper studies the optimal redistribution of income inequality caused by the presence of search and matching frictions in the labor market. We study this problem in the context of a directed search model of the labor market populated by homogenous workers and heterogeneous firms. The optimal redistribution can be attained using a positive unemployment benefit and an increasing and regressive labor income tax. The positive unemployment benefit serves the purpose of lowering the search risk faced by workers. The increasing and regressive labor tax serves the purpose of aligning the cost to the firm of attracting an additional applicant with the value of an application to society.
This paper studies models of credit with limited commitment and, therefore, endogenous debt limits. There are multiple stationary equilibria, plus nonstationary equilibria where credit conditions change simply due to beliefs. There can be equilibria where debt limits display deterministic cyclic or chaotic dynamics, as well as stochastic (sunspot) equilibria where they fluctuate randomly, even though fundamentals are deterministic and time invariant. Examples and applications are discussed. We also consider different mechanisms for determining the terms of trade, and compare the setup to other credit models in the literature.
We provide experimental evidence that subjects blame others for events they are not responsible for. An agent chooses between a lottery and a safe asset for a principal who then decides how much to allocate between the agent and a third party. We observe widespread blame: agents are blamed by principals for the outcome of the lottery, an event they are not responsible for. We provide an explanation of this apparently irrational behavior with a delegated-expertise principal-agent model, the subjects’ salient perturbation of the environment. By guaranteeing individual accountability, blame can be rationalized as part of a normative morality.
We introduce a model in which agents in a network can trade via bilateral contracts. We find that when continuous transfers are allowed and utilities are quasilinear, the full substitutability of preferences is sufficient to guarantee the existence of stable outcomes for any underlying network structure. Furthermore, the set of stable outcomes is essentially equivalent to the set of competitive equilibria, and all stable outcomes are in the core and are efficient. By contrast, for any domain of preferences strictly larger than that of full substitutability, the existence of stable outcomes and competitive equilibria cannot be guaranteed.
In one-good international macro models with nondiversifiable labor income risk, country portfolios are heavily biased toward foreign assets. The fact that the opposite pattern of diversification is observed empirically constitutes the international diversification puzzle. This paper embeds a portfolio choice decision in a two-country, two-good version of the stochastic growth model. In this environment, which is a workhorse for international business cycle research, equilibrium country portfolios can be characterized in closed form. Portfolios are biased toward domestic assets, as in the data. Home bias arises because endogenous international relative price fluctuations make domestic assets a good hedge against labor income risk. Evidence from developed economies in recent years is qualitatively and quantitatively consistent with the mechanisms highlighted by the theory.
We study the cyclical implications of credit market imperfections in a dynamic, stochastic general equilibrium model wherein firms face persistent shocks to both aggregate and individual productivity. In our model economy, optimal capital reallocation is distorted by two frictions. First, collateralized borrowing constraints limit the investment undertaken by small firms with relatively high productivity. Second, specificity in firm-level capital implies partial investment irreversibilities that lead firms to pursue (S,s) decision rules. This second friction compounds the first in implying that a subset of firms carries a share of the aggregate capital stock disproportionate to their productivity, thereby reducing endogenous aggregate total factor productivity. In the presence of persistent heterogeneity in capital, debt and total factor productivity, the effects of a financial shock are amplified and propagated through large and long-lived disruptions to the distribution of capital that, in turn, imply large and persistent reductions in aggregate total factor productivity. Measuring these effects in a quantitative model, we find that an unanticipated tightening in borrowing conditions can, on its own, generate a large recession more persistent than the financial shock itself. This recession, and the subsequent recovery, is distinguished both quantitatively and qualitatively from that driven by exogenous shocks to total factor productivity.
We use detailed data from an assembly plant of a major auto producer to investigate the learning by doing process. We focus on the acquisition, aggregation, transmission, and embodiment of the knowledge stock built through learning. We find that most of the substantial learning by doing knowledge at the plant was not retained by the plant’s workers, even though they were an important conduit for knowledge acquisition. This finding is consistent with the plant’s institutionalized systems for productivity measurement and improvement. We further explore how overall learning is undergirded by what happens at the hundreds of individual processes along the production line. Our results shed light not only on how productivity gains accrue at the plant level, but also how firms apply managerial inputs to expand production.
We analyze a model economy with many agents, each with a different productivity level. Agents divide their time between two activities: producing goods with the production-related knowledge they already have, and interacting with others in search of new, productivity-increasing ideas. These choices jointly determine the economy’s current production level and its rate of learning and real growth. We construct the balanced growth path for this economy, thereby obtaining a theory of endogenous growth that captures in a tractable way the social nature of knowledge creation. We show, for example, that a fatter right tail of the initial productivity distribution leads to higher individual search effort and higher long-run growth. We also study the allocation chosen by an idealized planner who takes into account and internalizes the external benefits of search, and tax structures that implement an optimal solution. Finally, we provide three examples of alternative learning technologies and show that the properties of equilibrium allocations are quite sensitive to these variations.
Economic variables are known to move asymmetrically over the business cycle: quickly and sharply during crises, but slowly and gradually during recoveries. Not known is the fact that this asymmetry is stronger in countries with less-developed financial systems. I document this new fact using cross-country data on loan interest rates, investment, and output. I then explain it using a learning model with endogenous flows of information about economic conditions. Asymmetry is shown to be stronger in less-developed countries because these countries have greater financial frictions, which are captured in the model by higher monitoring and bankruptcy costs. These greater frictions magnify the reaction of lending rates and economic activity to shocks and then delay their recovery by restricting the generation of information after a crisis. Empirical evidence and a quantitative exploration of the model show that this explanation is consistent with the data.
The least productive agents in an economy can be vital in generating growth by spurring technology diffusion. We develop an analytically tractable model where growth is created as a positive externality from risk taking by firms at the bottom of the productivity distribution imitating more productive firms. Heterogeneous firms choose to produce or pay a cost and search within the economy to upgrade their technology. Sustained growth comes from the feedback between the endogenously determined distribution of productivity, as evolved by past search decisions, and an optimal forward looking search policy. The growth rate depends on characteristics of the productivity distribution, with a thicker tailed distribution leading to more growth.
How do discount rates affect agents' decisions and valuations? This paper provides a common methodology and a systematic analysis of this question, considering stochastic and managed cash-flows, stochastic discount rates, time inconsistency, and including arbitrary learning and payoff or utility processes. We show that some of these features can lead to counter-intuitive answers (e.g., “a more patient agent stops earlier"), but we also establish, under simple conditions, theorems yielding robust and unifying answers on the impact of discount rates on control and stopping decisions and on valuations. We apply our theory to models of search, experimentation, bankruptcy, optimal growth, investment, and social learning.
Assuming Brownian/Poisson uncertainty, a certainty equivalent (CE) based on the smooth second-order expected utility of Klibanoff, Marinacci, and Mukerji (Econometrica, 2005) is shown to be approximately equal to an expected-utility CE. As a consequence, the corresponding continuous-time recursive utility form is the same as for Kreps-Porteus utility. The analogous conclusions are drawn for a smooth divergence CE, based on a formulation of Maccheroni, Marinacci, and Rustichini (Econometrica, 2006), but only under Brownian uncertainty. Under Poisson uncertainty, a smooth divergence CE can be approximated with an expected-utility CE if and only if it is of the entropic type. A non-entropic divergence CE results in a new class of continuous-time recursive utilities that price Brownian and Poissonian risks differently.
In a recent and insightful paper, Echenique et al. proposed the Money Pump Index (MPI) as an intuitive measure to evaluate the severity of violations of consumer rationality (defined in terms of revealed preference axioms). For practical applications, they suggest using the Mean or Median MPI. In this note, we show that computing these Median and Mean MPIs is computationally hard, which makes them impractical in the case of large datasets (including “scanner" datasets as the one used by Echenique et al.). To overcome this problem, we propose Maximum and Minimum MPIs as easy-to-apply alternatives. These MPIs preserve the intuition of the Median and Mean MPIs and can be computed efficiently (i.e. in polynomial time). We also show the practical usefulness of the Maximum and Minimum MPIs through an application to the dataset of Echenique et al.
When there is a market for inventions, competitive pressures increase incentives to innovate. Greater competition among producers, the demand side of the market for inventions, increases incentives to innovate by generating more entry of competing inventors and by inducing more effort for the multi-project monopoly inventor. Competition among inventors, the supply side of the market for inventions, increases incentives to innovate by improving the quality of inventions and lowering royalties charged to producers. This is because average expected returns to invention for competing inventors are greater than incremental expected returns to invention for the multi-project monopoly inventor. The traditional inertia effect is reversed for the multi-project monopoly inventor; a better initial technology increases incentives to invent. Competition among inventors increases economic efficiency relative to the multi-project monopoly inventor.