Information Frictions in Trade

It is costly to learn about market conditions elsewhere, especially in developing countries. This paper examines how such information frictions affect trade. Using data on regional agricultural trade in the Philippines, I first document a number of observed patterns in trade flows and prices that suggest the presence of information frictions. I then incorporate information frictions into a perfect competition trade model by embedding a process whereby heterogeneous producers engage in a costly sequential search process to determine where to sell their produce. I show that introducing information frictions reconciles the theory with the observed patterns in the data. Structural estimation of the model finds that information frictions are quantitatively important: roughly half the observed regional price dispersion is due to information frictions. Furthermore, incorporating information frictions improves the out‐of‐sample predictive power of the model.     

Leverage and Default in Binomial Economies: A Complete Characterization

Our paper provides a complete characterization of leverage and default in binomial economies with financial assets serving as collateral. Our Binomial No‐Default Theorem states that any equilibrium is equivalent (in real allocations and prices) to another equilibrium in which there is no default. Thus actual default is irrelevant, though the potential for default drives the equilibrium and limits borrowing. This result is valid with arbitrary preferences and endowments, contingent or noncontingent promises, many assets and consumption goods, production, and multiple periods. We also show that only no‐default equilibria would be selected if there were the slightest cost of using collateral or handling default. Our Binomial Leverage Theorem shows that equilibrium Loan to Value (LTV) for noncontingent debt contracts is the ratio of the worst‐case return of the asset to the riskless gross rate of interest. In binomial economies, leverage is determined by down risk and not by volatility.     

An Empirical Equilibrium Model of a Decentralized Asset Market

I estimate a search‐and‐bargaining model of a decentralized market to quantify the effects of trading frictions on asset allocations, asset prices, and welfare, and to quantify the effects of intermediaries that facilitate trade. Using business‐aircraft data, I find that, relative to the Walrasian benchmark, 18.3 percent of the assets are misallocated; prices are 19.2 percent lower; and the aggregate welfare losses equal 23.9 percent. Dealers play an important role in reducing trading frictions: In a market with no dealers, a larger fraction of assets would be misallocated, and prices would be higher. However, dealers reduce aggregate welfare because their operations are costly, and they impose a negative externality by decreasing the number of agents' direct transactions.     

Equilibrium Labor Turnover,Firm Growth,and Unemployment

This paper considers equilibrium quit turnover in a frictional labor market with costly hiring by firms, where large firms employ many workers and face both aggregate and firm specific productivity shocks. There is exogenous firm turnover as new (small) startups enter the market over time, while some existing firms fail and exit. Individual firm growth rates are disperse and evolve stochastically. The paper highlights how dynamic monopsony, where firms trade off lower wages against higher (endogenous) employee quit rates, yields excessive job‐to‐job quits. Such quits directly crowd out the reemployment prospects of the unemployed. With finite firm productivity states, stochastic equilibrium is fully tractable and can be computed using standard numerical techniques.     

Efficient Competition Through Cheap Talk: The Case of Competing Auctions

We consider a large market where auctioneers with private reservation values compete for bidders by announcing cheap‐talk messages. If auctioneers run efficient first‐price auctions, then there always exists an equilibrium in which each auctioneer truthfully reveals her type. The equilibrium is constrained efficient, assigning more bidders to auctioneers with larger gains from trade. The choice of the trading mechanism is crucial for the result. Most notably, the use of second‐price auctions (equivalently, ex post bidding) leads to the nonexistence of any informative equilibrium. We examine the robustness of our finding in various dimensions, including finite markets and equilibrium selection.     

Market Microstructure Invariance: Empirical Hypotheses

Using the intuition that financial markets transfer risks in business time, “market microstructure invariance” is defined as the hypotheses that the distributions of risk transfers (“bets”) and transaction costs are constant across assets when measured per unit of business time. The invariance hypotheses imply that bet size and transaction costs have specific, empirically testable relationships to observable dollar volume and volatility. Portfolio transitions can be viewed as natural experiments for measuring transaction costs, and individual orders can be treated as proxies for bets. Empirical tests based on a data set of 400,000+ portfolio transition orders support the invariance hypotheses. The constants calibrated from structural estimation imply specific predictions for the arrival rate of bets (“market velocity”), the distribution of bet sizes, and transaction costs.     

Time‐Varying Risk Premium in Large Cross‐Sectional Equity Data Sets

We develop an econometric methodology to infer the path of risk premia from a large unbalanced panel of individual stock returns. We estimate the time‐varying risk premia implied by conditional linear asset pricing models where the conditioning includes both instruments common to all assets and asset‐specific instruments. The estimator uses simple weighted two‐pass cross‐sectional regressions, and we show its consistency and asymptotic normality under increasing cross‐sectional and time series dimensions. We address consistent estimation of the asymptotic variance by hard thresholding, and testing for asset pricing restrictions induced by the no‐arbitrage assumption. We derive the restrictions given by a continuum of assets in a multi‐period economy under an approximate factor structure robust to asset repackaging. The empirical analysis on returns for about ten thousand U.S. stocks from July 1964 to December 2009 shows that risk premia are large and volatile in crisis periods. They exhibit large positive and negative strays from time‐invariant estimates, follow the macroeconomic cycles, and do not match risk premia estimates on standard sets of portfolios. The asset pricing restrictions are rejected for a conditional four‐factor model capturing market, size, value, and momentum effects.     

Insider Trading,Stochastic Liquidity,and Equilibrium Prices

We extend Kyle's (1985) model of insider trading to the case where noise trading volatility follows a general stochastic process. We determine conditions under which, in equilibrium, price impact and price volatility are both stochastic, driven by shocks to uninformed volume even though the fundamental value is constant. The volatility of price volatility appears ‘excessive’ because insiders choose to trade more aggressively (and thus more information is revealed) when uninformed volume is higher and price impact is lower. This generates a positive relation between price volatility and trading volume, giving rise to an endogenous subordinate stochastic process for prices.     

Prices,Markups, and Trade Reform

This paper examines how prices, markups, and marginal costs respond to trade liberalization. We develop a framework to estimate markups from production data with multi‐product firms. This approach does not require assumptions on the market structure or demand curves faced by firms, nor assumptions on how firms allocate their inputs across products. We exploit quantity and price information to disentangle markups from quantity‐based productivity, and then compute marginal costs by dividing observed prices by the estimated markups. We use India's trade liberalization episode to examine how firms adjust these performance measures. Not surprisingly, we find that trade liberalization lowers factory‐gate prices and that output tariff declines have the expected pro‐competitive effects. However, the price declines are small relative to the declines in marginal costs, which fall predominantly because of the input tariff liberalization. The reason for this incomplete cost pass‐through to prices is that firms offset their reductions in marginal costs by raising markups. Our results demonstrate substantial heterogeneity and variability in markups across firms and time and suggest that producers benefited relative to consumers, at least immediately after the reforms.     

Earnings and Consumption Dynamics: A Nonlinear Panel Data Framework

We develop a new quantile‐based panel data framework to study the nature of income persistence and the transmission of income shocks to consumption. Log‐earnings are the sum of a general Markovian persistent component and a transitory innovation. The persistence of past shocks to earnings is allowed to vary according to the size and sign of the current shock. Consumption is modeled as an age‐dependent nonlinear function of assets, unobservable tastes, and the two earnings components. We establish the nonparametric identification of the nonlinear earnings process and of the consumption policy rule. Exploiting the enhanced consumption and asset data in recent waves of the Panel Study of Income Dynamics, we find that the earnings process features nonlinear persistence and conditional skewness. We confirm these results using population register data from Norway. We then show that the impact of earnings shocks varies substantially across earnings histories, and that this nonlinearity drives heterogeneous consumption responses. The framework provides new empirical measures of partial insurance in which the transmission of income shocks to consumption varies systematically with assets, the level of the shock, and the history of past shocks.     

A Rational Theory of Mutual Funds' Attention Allocation

The question of whether and how mutual fund managers provide valuable services for their clients motivates one of the largest literatures in finance. One candidate explanation is that funds process information about future asset values and use that information to invest in high‐valued assets. But formal theories are scarce because information choice models with many assets are difficult to solve as well as difficult to test. This paper tackles both problems by developing a new attention allocation model that uses the state of the business cycle to predict information choices, which in turn, predict observable patterns of portfolio investments and returns. The predictions about fund portfolios' covariance with payoff shocks, cross‐fund portfolio and return dispersion, and their excess returns are all supported by the data. These findings offer new evidence that some investment managers have skill and that attention is allocated rationally.     

Buy,Keep, or Sell: Economic Growth and the Market for Ideas

An endogenous growth model is developed where each period firms invest in researching and developing new ideas. An idea increases a firm's productivity. By how much depends on the technological propinquity between an idea and the firm's line of business. Ideas can be bought and sold on a market for patents. A firm can sell an idea that is not relevant to its business or buy one if it fails to innovate. The developed model is matched up with stylized facts about the market for patents in the United States. The analysis gauges how efficiency in the patent market affects growth.     

Organizational Integration for Product Development: The Effects on Glitches,On‐Time Execution of Engineering Change Orders,and Market Success

Deviations from requirements during the product development process can be considered as glitches. Fixing glitches, or problems, during the product development process consumes valuable resources, which may adversely affect product development time and hamper the firm's goal to pursue a first‐mover advantage. It is posited that an integrated organizational response can diminish incidences of glitches and improve the ability of the firm to respond to engineering changes, subsequently leading to improved market success. This organizational response frequently includes heavyweight product development managers who are seen as essential catalysts for internal integration. Though internal integration is vital, it is equally important to integrate with customers and suppliers alike because such network partners can provide access to information, knowledge, and unique and complementary resources that are otherwise unavailable to the firm. Findings, which are based on a sample of 191 product development projects in the automotive industry, suggest that some integration routines have a positive impact on product development outcomes and market success, while other routines can in fact hamper the collective effort.     

The Identification of Beliefs From Asset Demand

The demand for assets as prices and initial wealth vary identifies beliefs and attitudes towards risk. We derive conditions that guarantee identification with no knowledge either of the cardinal utility index (attitudes towards risk) or of the distribution of future endowments or payoffs of assets; the argument applies even if the asset market is incomplete and demand is observed only locally.     

Sentiments and Aggregate Demand Fluctuations

We formalize the Keynesian insight that aggregate demand driven by sentiments can generate output fluctuations under rational expectations. When production decisions must be made under imperfect information about demand, optimal decisions based on sentiments can generate stochastic self‐fulfilling rational expectations equilibria in standard economies without persistent informational frictions, externalities, nonconvexities, or strategic complementarities in production. The models we consider are deliberately simple, but could serve as benchmarks for more complicated equilibrium models with additional features.     

Identifying Equilibrium Models of Labor Market Sorting

We assess the empirical content of equilibrium models of labor market sorting based on unobserved (to economists) characteristics. In particular, we show theoretically that all parameters of the classic model of sorting based on absolute advantage in Becker, 1973 with search frictions can be nonparametrically identified using only matched employer–employee data on wages and labor market transitions. In particular, these data are sufficient to nonparametrically estimate the output of any individual worker with any given firm. Our identification proof is constructive and we provide computational algorithms that implement our identification strategy given the limitations of the available data sets. Finally, we add on‐the‐job search to the model, extend the identification strategy, and apply it to a large German matched employer–employee data set to describe detailed patterns of sorting and properties of the production function.     

Large Matching Markets as Two‐Sided Demand Systems

This paper studies two‐sided matching markets with non‐transferable utility when the number of market participants grows large. We consider a model in which each agent has a random preference ordering over individual potential matching partners, and agents' types are only partially observed by the econometrician. We show that in a large market, the inclusive value is a sufficient statistic for an agent's endogenous choice set with respect to the probability of being matched to a spouse of a given observable type. Furthermore, while the number of pairwise stable matchings for a typical realization of random utilities grows at a fast rate as the number of market participants increases, the inclusive values resulting from any stable matching converge to a unique deterministic limit. We can therefore characterize the limiting distribution of the matching market as the unique solution to a fixed‐point condition on the inclusive values. Finally we analyze identification and estimation of payoff parameters from the asymptotic distribution of observable characteristics at the level of pairs resulting from a stable matching.     

Program Evaluation and Causal Inference With High‐Dimensional Data

In this paper, we provide efficient estimators and honest confidence bands for a variety of treatment effects including local average (LATE) and local quantile treatment effects (LQTE) in data‐rich environments. We can handle very many control variables, endogenous receipt of treatment, heterogeneous treatment effects, and function‐valued outcomes. Our framework covers the special case of exogenous receipt of treatment, either conditional on controls or unconditionally as in randomized control trials. In the latter case, our approach produces efficient estimators and honest bands for (functional) average treatment effects (ATE) and quantile treatment effects (QTE). To make informative inference possible, we assume that key reduced‐form predictive relationships are approximately sparse. This assumption allows the use of regularization and selection methods to estimate those relations, and we provide methods for post‐regularization and post‐selection inference that are uniformly valid (honest) across a wide range of models. We show that a key ingredient enabling honest inference is the use of orthogonal or doubly robust moment conditions in estimating certain reduced‐form functional parameters. We illustrate the use of the proposed methods with an application to estimating the effect of 401(k) eligibility and participation on accumulated assets. The results on program evaluation are obtained as a consequence of more general results on honest inference in a general moment‐condition framework, which arises from structural equation models in econometrics. Here, too, the crucial ingredient is the use of orthogonal moment conditions, which can be constructed from the initial moment conditions. We provide results on honest inference for (function‐valued) parameters within this general framework where any high‐quality, machine learning methods (e.g., boosted trees, deep neural networks, random forest, and their aggregated and hybrid versions) can be used to learn the nonparametric/high‐dimensional components of the model. These include a number of supporting auxiliary results that are of major independent interest: namely, we (1) prove uniform validity of a multiplier bootstrap, (2) offer a uniformly valid functional delta method, and (3) provide results for sparsity‐based estimation of regression functions for function‐valued outcomes.     

Entry and Exit in OTC Derivatives Markets

We develop a parsimonious model to study the equilibrium and socially optimal decisions of banks to enter, trade in, and possibly exit, an OTC market. Although we endow all banks with the same trading technology, banks' optimal entry and trading decisions endogenously lead to a realistic market structure composed of dealers and customers with distinct trading patterns. We decompose banks' entry incentives into incentives to hedge risk and incentives to make intermediation profits. We show that dealer banks enter more than is socially optimal. In the face of large negative shocks, they may also exit more than is socially optimal when markets are not perfectly resilient.     

A Competitive Model of Customization with Lead‐Time Effects

In this article, we study the competitive interactions between a firm producing standard products and a firm producing custom products. Consumers with heterogeneous preferences choose between n standard products, which may not meet their preferences exactly but are available immediately, and a custom product, available only after a certain lead time l. Standard products incur a variety cost that increases with n and custom products incur a lead time cost that is decreasing in the lead time l. We consider a two‐stage game wherein at stage 1, the standard product firm chooses the variety and the custom firm chooses the lead time and then both firms set prices simultaneously. We characterize the subgame‐perfect Nash equilibrium of the game. We find that both firms can coexist in equilibrium, either sharing the market as local monopolists or in a price‐competitive mode. The standard product firm may offer significant or minimal variety depending on the equilibrium outcome. We provide several interesting insights on the variety, lead time, and prices of the products offered and on the impact of problem parameters on the equilibrium outcomes. For instance, we show that the profit margin and price of the custom product are likely to be higher than that of standard products in equilibrium under certain conditions. Also, custom firms are more likely to survive and succeed in product markets with larger potential market sizes. Another interesting insight is that increased consumer sensitivity to product fit may result in lower lead time for the custom product.