RISK AVERSION AND OVERBIDDING IN FIRST PRICE SEALED BID AUCTIONS: NEW EXPERIMENTAL EVIDENCE

Bidding above the risk‐neutral Nash equilibrium in first price sealed bid auctions has traditionally been ascribed to risk aversion. Later studies, however, offer other explanations and even argue that risk aversion plays no or a minor role. In a novel experimental design, we directly test the relationship between risk aversion and overbidding by systematically varying the distribution of risk attitudes in auction markets. We find a significant relationship between our measure of risk aversion and overbidding. (JEL D44, C91)     

ASYMMETRIC INFORMATION AND THE EXCESS VOLATILITY OF STOCK PRICES

Evidence suggests the volatility of stock prices cannot be accounted for by information about future dividends. We argue that some of the volatility of stock prices in excess of fundamentals results from fluctuations in the amount of public information over time. Our model assumes that dividends and consumption are constant in the aggregate but that there are good firms and bad firms whose identity may be unknown to the public, as in Akerlof's "lemons" problem. In that case, the collective valuation of the constant dividend stream depends on the degree of informational asymmetry.     

NEW FACTS ABOUT FIRM RISK ACROSS COUNTRIES AND OVER THE BUSINESS CYCLE

The characteristics of firm‐level risk over the cycle and across countries are studied in this paper. Low idiosyncratic firm‐level risk is found to be a feature of highly developed, stable economies, whereas the countercyclicality of firm‐level risk is associated with flexible as well as stable economies. These facts are uncovered with the help of a theoretical model where small, risk‐averse firms display procyclical risk, whereas larger, risk‐neutral firms have countercyclical risk patterns that depend on the rigidity of the business environment. The predictions of the model are then confirmed by the data using a large international firm‐level database (ORBIS) together with the World Bank Doing Business Database, during the “Great Recession” across 55 countries. The findings are critical for the growing literature of uncertainty driven business cycles, and show that firm‐level uncertainty cannot be treated as an exogenous parameter. (JEL D21, D22, E32, F44, L11, L25)     

IDENTIFYING THE ROLE OF RISK SHOCKS IN THE BUSINESS CYCLE USING STOCK PRICE DATA

I analyze the sources of U.S. business cycle fluctuations in an estimated Dynamic Stochastic General Equilibrium model with a rich set of nominal and real rigidities and various exogenous disturbances. The model includes a shock to the expected risk‐premium, which introduces a time‐varying wedge between the policy rate set by the central bank and the cost‐of‐capital of firms. In the aggregate data, most U.S. corporations finance their investment using internal funds, and stock prices reveal the opportunity cost of this type of financing. I therefore use corporate market value and dividend data in the Bayesian estimation of the model to identify risk shocks. Variance decomposition exercises show that these shocks account for a substantial part of the variation in the stock market, as well as the variation in output and investment, especially at short forecast horizons. The variation of these variables at longer forecast horizons are mainly captured by shocks to investment‐specific technological change. Historical decomposition points to the important role played by risk shocks in the run up of stock prices and output in the late 90s, and in the reversal of these variables in the early 2000s and during the recent recession. (JEL E32, E44)     

STOCK RETURNS, INFLATION, AND REAL OUTPUT

This paper provides empirical evidence on the extent to which the inverse relationship between real stock returns and inflation in recent years is causal or spurious. The results indicate that this relationship is spurious and can be explained by the inverse correlation between unexpected inflation and unexpected real output. The expected and unexpected real output and inflation variables are generated from the ASA/NBER Business Outlook Surveys.     

INTERMEDIATE INFORMATION,LOSS AVERSION,AND EFFORT: EMPIRICAL EVIDENCE

The present article empirically explores the impact of intermediate information on contestants' effort. Data involving substituted soccer players of the German Bundesliga indicate only weak evidence of a negative effect of ex ante heterogeneity on effort; in contrast, intermediate information, measured by goal difference at the time of substitution, significantly affects effort. Players exert the greatest effort when their team is leading by one goal and reduce their effort when it is trailing. When intermediate information suggests the contest is already decided, players from both teams reduce effort. This behavior is in line with loss aversion, such that players weight potential losses more than potential gains and adjust their effort accordingly. (JEL Z22, J41, M54)     

ASYMMETRIC SUBSTITUTABILITY: THEORY AND SOME APPLICATIONS

Economists usually describe goods as being either (gross) complements or (gross) substitutes. Yet, what is less known is that one good may be a gross substitute for a second good, while the second good is a gross complement to the first good. This article develops a theory of asymmetric gross substitutability and suggests some potential examples and applications. ( JEL D11)     

LOSS AVERSION AND MANAGERIAL DECISIONS: EVIDENCE FROM MAJOR LEAGUE BASEBALL

Previous research indicates that management changes are important events for organizations, partly because they lead to reversals of poor prior decisions. An unanswered question is why replacing the manager seems to be necessary for reversing poor decisions. One explanation is that managers have an irrational behavioral aversion to admitting mistakes (loss aversion). We test this hypothesis with a research design that mitigates many of the measurement problems associated with investment decisions in traditional corporate settings, and that allows us to distinguish agency cost from loss aversion as explanations. Using Major League Baseball data, we find that new managers, compared to continuing managers, are more likely to divest low‐performing players. Moreover, when the manager is new and the previous manager was responsible for acquiring a player who is underperforming, the likelihood of player divestiture is significantly higher relative to low performers acquired by earlier managers. Experience of the acquiring manager does not affect the likelihood that the manager retains a low performer, suggesting that it is loss aversion, and not career concerns, that motivates acquiring managers to retain low performers. The findings suggest that loss aversion plays a significant role in managerial decisions and managerial turnover. (JEL J6, L8, D8)     

ENTRY AND EXIT,PRODUCT VARIETY,AND THE BUSINESS CYCLE

We study the stochastic behavior of a dynamic general equilibrium model with monopolistic competition. Each seller sells his product in the consumption goods as well as the investment goods market and has market power in both. Consumers derive utility from a constant elasticity of substitution (CES) aggregate of all the consumption goods and augment their capital stock by a CES aggregate of all the investment goods. We analyze the equilibrium of this economy allowing for an endogenous determination of the number of firms and therefore of products. The principal effect we wish to highlight is the endogenous propagation and magnification of technology and preference disturbances through product space variations. (JEL E32, D43, L16)     

NONLINEAR BUSINESS CYCLE DYNAMICS: CROSS-COUNTRY EVIDENCE ON THE PERSISTENCE OF AGGREGATE SHOCKS

We look for asymmetries in the dynamics of real GDP growth for the G7 countries, using a model by Beaudry and Koop that allows the depth of a recession to influence the rate of growth of output. We find evidence supporting these nonlinearities in four countries, including the United States, but we do not find evidence that the asymmetries are common even among the four countries exhibiting asymmetric behavior. A modification of the model to distinguish between the recession and recovery phases of a business cycle does not change this general finding. The asymmetries discovered by Beaudry and Koop do not appear to be common among the G7 nations. (JEL E32)     

THE DURABILITY OF HUMAN CAPITAL: SOME NEW EVIDENCE

This paper analyzes the effect of chronological aging, experience, job search, change of job and/or employer, and formal training on the wage growth of a sample of young men. Following the human capital literature, wage growth directly corresponds to human capital and the analysis allows for the assessment of the durability or rate of depreciation of human capital if further investments are not made. The findings suggest that human capital is not very durable, contrary to some previous estimates given in the literature.     

INSTITUTIONS, INVESTMENT, AND GROWTH: NEW CROSS-COUNTRY AND PANEL DATA EVIDENCE

This paper outlines the alternative channels through which institutions affect growth, and studies the empirical relationship between institutions, investment, and growth. The empirical results indicate that (i) free-market institutions have a positive effect on growth; (ii) economic freedom affects growth through both a direct effect on total factor productivity and an indirect effect on investment; (iii) political and civil liberties may stimulate investment; (iv) an important interaction exists between freedom and human capital investment; (v) Milton Friedman's conjectures on the relation between political and economic freedom are correct; (vi) promoting economic freedom is an effective policy toward facilitating growth and other types of freedom. ( JEL O17, O40, P51)     

THEORIES OF RISK: TESTING INVESTOR BEHAVIOR ON THE TAIWAN STOCK AND STOCK INDEX FUTURES MARKETS

This article considers four utility functions—concave, convex, S‐shaped, and reverse S‐shaped—to analyze the behavior of different types of investors on the Taiwan stock index and its corresponding index futures. Using stochastic dominance (SD) rules, we show that the existence of all four investor types is plausible. Risk averters prefer spot to futures, whereas risk seekers prefer futures to spot. Investors with S‐shaped utility functions prefer spot (futures) to futures (spot) when markets move upward (downward). Investors with reverse S‐shaped utility functions prefer futures (spot) to spot (futures) when markets move upward (downward). We show that both spot and futures markets can exist when only risk averters are present, but futures can dominate spot only if there is some risk‐seeking behavior. These results are robust with respect to subperiods, spot returns including dividends, and diversification. (JEL C14, G12, G15)     

INFLATION, HEDGING AND THE DEMAND FOR MONEY: SOME EMPIRICAL EVIDENCE

This paper explores the role of nominal rate of return uncertainty and inflation hedging as potentially important factors explaining the pattern of money demand. Using U.S. quarterly data over the period 1952.2–1982.4, it is shown that in conformity with theoretical considerations the nominal rate of return uncertainty variable tends to have a significantly positive effect and the inflation hedging variable (the covariance between nominal rate of return and inflation rate) a significantly negative effect on the demand for money. These findings seem to be reasonably robust in terms of various definitions of income, interest rates, inflation rate and money variables as well as in terms of different estimation methods.     

PRICE FLEXIBILITY AND AGGREGATE STABILITY: NEW EVIDENCE AND IMPLICATIONS

The relation between price flexibility and aggregate real stability has been subject to recent debate. Increased price flexibility decreases the response of real output to aggregate demand shifts and, in turn, is stabilizing. The increased flexibility may exacerbate, however, the size of demand shifts induced by a given underlying shock. If the latter channel dominates, increased flexibility may prove destabilizing. This paper examines the real effects of specific shocks underlying aggregate demand across a group of eighteen major industrial countries. The stabilizing effect of price flexibility appears to dominate.     

RISK PREFERENCES AND EXPECTED UTILITY: EVIDENCE FROM LABOR SUPPLY DATA

This paper adds to the growing body of evidence that observed risk preferences are not consistent with expected‐utility theory. Using the link between labor supply decisions and utility as outlined by Chetty (“A Bound on Risk Aversion Using Labor Supply Elasticities.” The American Economic Review, 96(5), 2006, 1821–34), I compute the curvature of utility over wealth for 3,900 individuals in the 1996 Panel Study of Income Dynamics. I then compare this estimate to a measure of relative risk aversion based on the respondents' answers to hypothetical gambling questions and find virtually zero correlation. Finally, I investigate how the two measures and their correlations change by demographic groups and risky behavior. (JEL C81, D80, J22)     

INEQUALITY AND TRUST: NEW EVIDENCE FROM PANEL DATA

We estimate the causal link from income inequality to generalized trust by reconsidering the country‐level evidence on this issue. First, we exploit the panel dimension of the data, thus controlling for any country unobservable time‐invariant variables, and find a negative relationship between the two variables that holds only for developed countries. Second, we focus on these advanced economies and provide instrumental variable estimates using the predicted exposure to technological change as an exogenous driver of inequality. According to our findings, the negative causal effect of inequality on trust is even larger than that coming from ordinary least squares estimation. We also provide new insights on the effects of different dimensions of inequality, exploiting measures of both static inequality—such as the Gini index and top income shares—and dynamic inequality—proxied by intergenerational income mobility. (JEL D31, O15, Z13)     

SOCIAL PREFERENCES AND TAX POLICY DESIGN: SOME EXPERIMENTAL EVIDENCE

This article reports the results of a set of experiments designed to examine whether a taste for fairness affects people's preferred tax structure. Using the Fehr and Schmidt model, we devise a simple test for the presence of social preferences in voting for alternative tax structures. The experimental results show that individuals demonstrate concern for their own payoff and inequality aversion in choosing between alternative tax structures. However, concern for redistribution decreases as the deadweight loss from progressive taxation increases. Our findings have important implications for tax policy design. ( JEL C92, D63, H21, H23)