hero working papers

Working papers

IGIER fellows and affiliates publish books and articles in academic journals. Their current research projects are featured in the Working Paper series. 

2013 - n° 507
In this paper we review some recent work on public intervention in economic environments where fifirms undertake investments in research or in physical assets, and then choose appropriate business practices to extract profits from the outcomes of the investment process. Public policies may take different forms: the release of an authorization; the setting of fines and damages for liability; or the choice of legal standards in antitrust law enforcement. The business practices are privately profitable but may be welfare enhancing or socially harmful. When expectations are optimistic, public policies face a trade-off between ex-ante effects on investment, that suggest hands off, and ex-post control of practices when harmful, that requires intervention. Our general result suggests that public policies should be softer when innovation is an important source of welfare improvements.

Giovanni Immordino, Michele Polo
Keywords: Regulation, Antitrust, Legal Standards
2013 - n° 506

Experimental evidence suggests that agents in social dilemmas have belief-dependent, otherregarding preferences. But in experimental games such preferences cannot be common knowledge, because subjects play with anonymous co-players. We address this issue theoretically and experimentally in the context of a trust game, assuming that the trustee's choice may be affected by a combination of guilt aversion and intention-based reciprocity. We recover trustees' belief-dependent preferences from their answers to a structured questionnaire. In the main treatment, the answers are disclosed and made common knowledge within each matched pair, while in the control treatment there is no disclosure. Our main auxiliary assumption is that such disclosure approximately implements a psychological game with complete information. To organize the data, we classify subjects according to their elicited preferences, and test predictions for the two treatments using both rationalizability and equilibrium. We find that guilt aversion is the prevalent psychological motivation, and that behavior and elicited beliefs move in the direction predicted by the theory.



Giuseppe Attanasi, Pierpaolo Battigalli, Elena Manzoni, Rosemarie Nagel
Keywords: Experiments, trust game, guilt, reciprocity, complete and incomplete information
2013 - n° 505
An extensive literature has studied lobbying by special interest groups. We analyze a novel lobbying channel: lobbying businessmen-politicians through business proxies. When a politician controls a business, firms attempting to curry favors shift their spending towards the politician's business. The politician benefits from increased revenues, and the firms hope for favorable regulation in return. We investigate this channel in Italy where government members, including the prime minister, are not required to divest business holdings. We examine the evolution of advertising spending by firms over the period 1994 to 2009, during which Silvio Berlusconi was prime minister on and off three times, while maintaining control of Italy's major private television network, Mediaset. We predict that firms attempting to curry favor with the government shift their advertising budget towards Berlusconi's channels when Berlusconi is in power. Indeed, we document a significant pro-Mediaset bias in the allocation of advertising spending during Berlusconi's political tenure. This pattern is especially pronounced for companies operating in more regulated sectors, as predicted. Using a model of supply and demand in the advertising market, we estimate one billion euros of extra revenue to Berlusconi's group. We also estimate the expected returns in regulation to politically motivated spenders of similar magnitude, stressing the economic importance of this lobbying channel. These findings provide an additional rationale for rules on conflict of interest.
Stefano DellaVigna, Ruben Durante, Brian Knight, Eliana La Ferrara
2013 - n° 504
We use frequency domain techniques to estimate a medium-scale DSGE model on different frequency bands. We show that goodness of t, forecasting performance and parameter estimates vary substantially with the frequency bands over which the model is estimated. Estimates obtained using subsets of frequencies are characterized by signicantly different parameters, an indication that the model cannot match all frequencies with one set of parameters. In particular, we find that: i) the low frequency properties of the data strongly affect parameter estimates obtained in the time domain; ii) the importance of economic frictions in the model changes when different subsets of frequencies are used in estimation.
This is particularly true for the investment cost friction and habit persistence: when low
frequencies are present in the estimation, the investment cost friction and habit persistence are estimated to be higher than when low frequencies are absent.

Keywords: DSGE models, frequency domain, band maximum likelihood
2013 - n° 503
This paper proposes a framework to evaluate the impact of longevity-linked securities on the risk-return trade-off for traditional portfolios. Generalized unexpected raise in life expectancy is a source of aggregate risk in the insurance sector balance sheets. Longevity-linked securities are a natural instrument to reallocate these risks by making them tradable in the financial market. This paper extends the strategic asset allocation model of (Campbell Viceira 2005) to include a longevity-linked investment in addition to equity and fixed income securities and describe the resulting term structure of risk-return trade-offs. The model highlights an unexpected predictability pattern of the survival probability estimates and gives an empirical valuation of the market price of longevity risk based on the LeeCarter(1992) mortality model and on the time series of prices for standardized annuities publicly offered by US insurance companies.

Emilio Bisetti, Carlo A. Favero, Giacomo Nocera, Claudio Tebaldi
Keywords: Longevity Risk, Strategic Asset Allocation
2013 - n° 502
We evaluate the impact of timing on decision outcomes, when both the timing and the relevant decision are chosen under uncertainty. Sports betting provides the testing ground, as we exploit an original dataset containing more than one million online bets on games of the Italian Major Soccer League. We find that individuals perform systematically better when they place their bets farther away from the game day. The better performance of early bettors holds controlling for (time-invariant) unobservable ability, learning during the season, and timing of the odds. We attribute this result to the increase of noisy information on game day, which hampers the capacity of late (non-professional) bettors to use very simple prediction methods, such as team rankings or last game results. We also find that more successful bettors tend to bet in advance, focus on a smaller set of events, and prefer games associated with smaller betting odds.

Alessandro Innocenti, Tommaso Nannicini, Roberto Ricciuti
Keywords: sports betting, decision timing, information overload, forecasting
2013 - n° 501
This paper addresses the problem of sequentially allocating timesensitive goods, or one-period leases on a durable good, among agents who compete through time and learn about the common component of the value of the allocation through experience. I show that efficiency is unattainable, and I identify simple variations of sequential second-price or English auctions that implement the second best and the revenuemaximizing auction. When the units are divisible, I also identify the corresponding auctions that allow for double sourcing.

Alejandro Francetich
Keywords: Dynamic mechanism design, sequential auctions, interdependent values, multi-dimensional types, winner's curse, double sourcing
2013 - n° 500
We establish an Ergodic Theorem for lower probabilities, a generalization of standard probabilities widely used in applications. As an application, we provide a version for lower probabilities of the Strong Law of Large Numbers.
S. Cerreia-Vioglio, F. Maccheroni, and M. Marinacci
2013 - n° 499
We thoroughly study the non-standard optimal exercise policy associated with relevant capital investment options and with the prepayment option of widespread collateralized-borrowing contracts like the gold loan. Option exercise is optimally postponed not only when moneyness is insufficient but also when it is excessive. We contribute an important extension of the classical optimal exercise properties for American options. Early exercise of an American call with a negative underlying payout rate can occur if the option is moderately in the money. We fully characterize the existence, the monotonicity, the continuity, the limits and the symptotic behavior at maturity of the double free boundary that separates the exercise region from the double continuation region. We fifind that the fifinite-maturity non-standard policy conspicuously differs from the infifinite-maturity one.

Anna Battauz, Marzia De Donno, Alessandro Sbuelz
Keywords: American Options; Valuation; Optimal Exercise; Real Options; Gold Loan; Collateralized Borrowing; Asymptotic Approximation of The Free Boundary
2013 - n° 498

We study a Mean-Risk model derived from a behavioral theory of Disappointment with multiple reference points. One distinguishing feature of the risk measure is that it is based on mutual deviations of outcomes, not deviations from a specific target. We prove necessary and sufficient conditions for strict first and second order stochastic dominance, and show that the model is, in addition, a Convex Risk Measure. The model allows for richer, and behaviorally more plausible, risk preference patterns than competing models with equal degrees of freedom, including Expected Utility (EU), Mean-Variance (MV), Mean-Gini (MG), and models based on non-additive probability weighting, such a Dual Theory (DT). For example, in asset allocation, the decision-maker can abstain from diversifying in a risky asset unless it meets a threshold performance, and gradually invest beyond this threshold, which appears more acceptable than the extreme solutions provided by either EU and MV (always diversify) or DT and MG (always plunge). In asset trading, the model allows no-trade intervals, like DT and MG, in some, but not all, situations. An illustrative application to portfolio selection is presented. The model can provide an improved criterion for Mean-Risk analysis by injecting a new level of behavioral realism and flexibility, while maintaining key normative properties.

Alessandra Cillo, Philippe Delquié
Keywords: Risk analysis; Uncertainty modeling; Utility theory; Stochastic dominance; Convex risk measures
2013 - n° 497
Gender stereotypes are well established also among women. Yet, a recent literature suggests that earning from other women experience about the effects of maternal employment on children outcomes may increase female labor force participation. To further explore this channel, we design a randomized survey experiment, in which 1500 Italian women aged 20 to 40 are exposed to two informational treatments on the positive consequences of formal childcare on children future educational attainments. Surprisingly, we find that women reduce their intended labor supply.
However, this result hides strong heterogenous effects: high educated non-mothers are persuaded by the informational treatments to increase their intended use of formal child care (and to pay more); whereas low educated non-mothers to reduce their intended labor supply. These findings are consistent with women responding to monetary incentive and/or having different preferences for maternal care. These heterogenous responses across women send a warning signal about the true effectiveness - in terms of take up rates - of often advocated public policies regarding formal child care.

Vincenzo Galasso, Paola Profeta, Chiara Pronzato, Francesco Billari
Keywords: gender culture, female labour supply, education
2013 - n° 496
We performed a new test of transitivity based on individual measurements of the main intransitive choice models in decision under uncertainty. Our test is tailor-made and, therefore, more likely to detect violations of transitivity than previous tests. In spite of this, we observed only few intransitivities and we could not reject the hypothesis that these were due to random error. A possible explanation for the poor predictive performance of the intransitive choice models is that they only allow for interactions between acts, but exclude within-act interactions by retaining the assumption that preferences are separable overstates of nature. Prospect theory, which relaxes separability but retains transitivity, predicted choices significantly better than the nontransitive choice models. We conclude that descriptively realistic models need to allow for within-act interactions, but may retain transitivity.

Subject classifications: Utility/preference: Estimation. Decision analysis: Risk.

Area of review: Decision Analysis.

Aurélien Baillon, Han Bleichrodt, Alessandra Cillo
2013 - n° 495
This work addresses the early phases of the elicitation of multiattribute value functions proposing a practical method for assessing interactions and monotonicity. We exploit the link between multiattribute value functions and the theory of high dimensional model representations. The resulting elicitation method does not state any a-priori assumption
on an individual's preference structure. We test the approach via an experiment in a riskless context in which subjects are asked to evaluate mobile phone packages that differ on three attributes.

Francesca Beccacece, Emanuele Borgonovo, Greg Buzzard, Alessandra Cillo, Stanley Zionts
Keywords: Multiattribute Utility Theory; High Dimensional Model Representations; Value Function Elicitation; Sparse Grid Interpolation
2013 - n° 494
We provide experimental evidence that subjects blame others based on events they are not
responsible for. In our experiment an agent chooses between a lottery and a safe asset; payment from the chosen option goes to a principal who then decides how much to allocate between the agent and a third party. We observe widespread blame: regardless of their choice, 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.

Mehmet Gurdal, Joshua B. Miller, Aldo Rustichini
Keywords: Experiments; Rationality; Fairness
2013 - n° 493
Trading venues often impose a minimum trade unit constraint (MTUC) to facilitate order execution. This paper examines the effects of a natural experiment at Borsa Italiana where the exchange reduced the MTUC to one share for all stocks. After the removal of the MTUC, we observe a substantial improvement in liquidity, measured by a decrease in the bid-ask spread and an increase in market depth. The cross-sectional evidence shows that those firms for which the MTUC was more binding benefit the most from the microstructure change. These findings are consistent with a model of asymmetric information in which the MTUC affects traders' choice of order size. As the model predicts, liquidity improves following the reduction in adverse selection costs.

Arie E. Gozluklu, Pietro Perotti, Barbara Rindi, Roberta Fredella
Keywords: minimum trade unit constraint, limit order book, market liquidity, adverse selection costs
2013 - n° 492
We show that following a tick size reduction in a decimal public limit order book (PLB) market quality and welfare fall for illiquid but increase for liquid stocks. If a Sub-Penny Venue (SPV) starts competing with a penny-quoting PLB, market quality deteriorates for illiquid, low priced stocks, while it improves for liquid, high priced stocks. As all traders can demand liquidity on the SPV, traders' welfare increases. If the PLB facing competition from a SPV lowers its tick size, PLB spread and depth decline and total volume and welfare increase irrespective of stock liquidity.
Sabrina Buti, Barbara Rindi, Yuanji Wen, Ingrid M. Werner
2013 - n° 491
A structural Factor-Augmented VAR model is used to evaluate the role of 'news' shocks in generating the business cycle. We find that (i) existing small-scale VAR models are affected by 'non-fundamentalness' and therefore fail to recover the correct shock and impulse response functions; (ii) news shocks have a smaller role in explaining the business cycle than previously found in the literature; (iii) their effects are essentially in line with what predicted by standard theories; (iv) a substantial fraction of business cycle
uctuations are explained by shocks unrelated to technology.

Mario Forni, Luca Gambetti,Luca Sala
Keywords: Factor-augmented VAR, news shocks, invertibility, fundamentalness
2013 - n° 490
We exploit a change in compulsory schooling laws in Turkey to estimate the causal effects of
education on religiosity and women's empowerment. A new law implemented in 1998 resulted in individuals born after a specific date to be more likely to complete at least 8 years of schooling while those born earlier could drop out after 5 years. This allows the implementation of a Regression Discontinuity (RD) Design and the estimation of meaningful causal estimates of schooling. Using the 2008 Turkish Demographic Health Survey, we show that the reform resulted in a one-year increase in years of schooling among women on average. Over a period of ten years, this education increase resulted in women reporting lower levels of religiosity, greater decision rights over marriage and higher household consumption (of durables). We find that these effects work through different channels, depending on women's family background. For women whose mothers had no formal education, the reform resulted in them only finishing the compulsory schooling and having higher labor force participation. For women whose mothers had some formal education, the reform had persistent effects beyond compulsory schooling, and these women were subsequently married to more educated (and possibly wealthier) husbands but remained outside the labor force. We interpret these findings as evidence that education may empower women across a wide spectrum of a Muslim society, yet, depending on pre-reform constraints to participation, its effects may not be strong enough to fully overcome participation constraints (in education or the labor force).

Selim Gulesci, Erik Meyersson
2013 - n° 489
In this paper we estimate the marriage market returns to being admitted to a higher ranked (i.e. more "elite") university by exploiting unique features of the Chilean university admission system.This system centrally allocates applicants based on their university entrance test score, which allows us to identify causal effects by using a regression discontinuity approach. Moreover, the Chilean context provides us with the necessary data on the long run outcome 'partner quality'. We find that being admitted to a higher ranked university has substantial returns in terms of partner quality for women, while estimates for men are about half the size and not significantly different from zero.

Katja Maria Kaufmann, Matthias Messner, Alex Solis
Keywords: Returns to education quality, higher education, marriage market, regression discontinuity, Chile
2013 - n° 488
Many violations of the Independence axiom of Expected Utility can be traced to subjects' attraction to risk-free prospects. Negative Certainty Independence, the key axiom in this paper, formalizes this tendency. Our main result is a utility representation of all preferences over monetary lotteries that satisfy Negative Certainty Independence together with basic rationality postulates. Such preferences can be represented as if the agent were unsure of how risk averse to be when evaluating a lottery p; instead, she has in mind a set of possible utility functions over outcomes and displays a cautious behavior: she computes the certainty equivalent of p with respect to each possible function in the set and picks the smallest one. The set of utilities is unique in a well-defined sense. We show that our representation can also be derived from a 'cautious' completion of an incomplete preference relation.

Simone Cerreia-Vioglio David Dillenberger Pietro Ortoleva
Keywords: Preferences under risk, Allais paradox, Negative Certainty Independence, Incomplete preferences, Cautious Completion, Multi-Utility representation
2013 - n° 487
This paper investigates the differential response of male and female voters to competitive persuasion in political campaigns. During the 2011 municipal elections in Milan, a sample of eligible voters was randomly divided into three groups. Two were exposed to the same incumbent's campaign but to different opponent's campaigns, with either a positive or a negative tone. The third-control-group received no electoral information. The campaigns were administered online and consisted of a bundle of advertising tools (videos, texts, slogans). Stark gender differences emerge. Negative advertising increases men's turnout, but has no effect on women. Females, however, vote more for the opponent and less for the incumbent when they are exposed to the opponent's positive campaign. Exactly the opposite occurs for males. Additional tests show that our results are not driven by gender identification with the candidate, ideology, or other voter's observable attributes. Effective strategies of persuasive communication should thus take gender into account. Our results may also help to reconcile the conflicting evidence on the effect of negative vs. positive advertising, as the average impact may wash out when aggregated across gender.

Vincenzo Galasso, Tommaso Nannicini
Keywords: gender differences, political campaigns, competitive persuasion
2013 - n° 486
Rational voters update their subjective beliefs about candidates' attributes with the arrival of information, and subsequently base their votes on these beliefs. Information accrual is, however, endogenous to voters' types and difficult to identify in observational studies. In a large scale randomized trial conducted during an actual mayoral campaign in Italy, we expose different areas of the polity to controlled informational treatments about the valence and ideology of the incumbent through verifiable informative messages sent by the incumbent reelection campaign. Our treatments affect both actual vote shares at the precinct level and vote declarations at the individual level. We explicitly investigate the process of belief updating by comparing the elicited priors and posteriors of voters, finding heterogeneous responses to information. Based on the elicited beliefs, we are able to structurally assess the relative weights voters place upon a candidate's valence and ideology. We find that both valence and ideological messages affect the first and second moments of the belief distribution, but only campaigning on valence brings more votes to the incumbent. With respect to ideology, cross-learning occurs, as voters who receive information about the incumbent also update their beliefs about the opponent. Finally, we illustrate how to perform counterfactual campaigns based upon the structural model.

Chad Kendall, Tommaso Nannicini, Francesco Trebbi
Keywords: voting, information, beliefs elicitation, randomized controlled trial
2013 - n° 485
In a decision problem under uncertainty, a decision maker considers a set of alternative actions whose consequences depend on uncertain factors outside his control. Following Luce and Raiffa (1957), we adopt a natural representation of such situation that takes as primitives a set of conceivable actions A, a set of states S and a consequence function from actions and states to consequences in C. With this, each action induces a map from states to consequences, or Savage act, and each mixed action induces a map from states to probability distributions over consequences, or Anscombe-Aumann act. Under a consequentialist axiom, preferences over pure or mixed actions yield corresponding preferences over the induced acts. The most common approach to the theory of choice under uncertainty takes instead as primitive a preference relation over the set of all Anscombe-Aumann acts (functions from states to distributions over consequences). This allows to apply powerful convex analysis techniques, as in the seminal work of Schmeidler (1989) and the vast descending literature. This paper shows that we can maintain the mathematical convenience of the Anscombe-Aumann framework within a description of decision problems which is closer to applications and experiments. We argue that our framework is more expressive, it allows to be explicit and parsimonious about the assumed richness of the set of conceivable actions, and to directly capture preference for randomization as an expression of uncertainty aversion.

Pierpaolo Battigalli, Simone Cerreia-Vioglio, Fabio Maccheroni, Massimo Marinacci
2013 - n° 484
We examine a number of unexplored factors that affect the ex-post adoption rates of newly listed stock options. We show that a variety of measures of information asymmetries for underlying stocks predict option adoption rates. This occurs even when we control for factors that have been found to be significant in earlier literature, such as stock volatility and volume. However, option listings induce a reduction in the strength of the information asymmetries in the underlying stock. Further, option bid-ask spreads start from low initial levels and increase over time, which is consistent with a modest initial aggressiveness of informed investors.

Alejandro Bernales and Massimo Guidolin
Keywords: Stock options; option listings; asymmetric information; adoption rates; option volume, open interest
2013 - n° 483
We examine asset allocation decisions under smooth ambiguity aversion when an investor has a prior degree of belief in an asset pricing model (e.g., the domestic CAPM). Different from the Bayesian portfolio approach, in our model the investor separately relies on the conditional distribution of returns and on the posterior over uncertain parameters to make asset allocation decisions, rather than on the predictive distribution of returns that integrates priors and likelihood information in a single distribution. This is a key feature implied by smooth ambiguity preferences. We find that in the perspective of US investors, ambiguity aversion can generate strong home bias in their equity holdings, regardless of their belief in the domestic CAPM or of their degree of risk aversion. Our results extend and become stronger under regime-switching investment opportunities.

Massimo Guidolin, Hening Liu
Keywords: Ambiguity aversion, Bayesian portfolio analysis, CAPM, Smooth ambiguity
2013 - n° 482
We investigate the lead-lag relationships between issuer- and investor-paid credit rating agencies, in the aftermath of the regulatory reforms undertaken in the U.S. between 2002 and 2006 -including watch list inclusions and outlooks. First, we find that the lead effect of investor-paid over issuer-paid credit rating agencies has weakened: in recent years, causality has turned bi-directional. Second, when changes in outlooks are included, we find evidence of a less conservative behavior by issuer-paid agencies, when compared to their rating behavior. Third, stock prices manifest statistically significant abnormal reactions to downgrades of all agencies; however, abnormal negative returns are significantly higher for investor-paid downgrades. Our results support the hypothesis that when issuer-paid agencies have seen their market power threatened by tighter regulations, they have felt incentives to improve the quality and timeliness of their ratings. However, event studies show that markets still price stocks under the assumption that investor-paid rating actions carry superior information.

Erik Berwart, Massimo Guidolin, and Andreas Milidonis
Keywords: rating agencies, timeliness, issuer-paid agencies, investor-paid business model, NRSRO
2013 - n° 481
This paper employs a recent statistical algorithm (CRAGGING) in order to build an early warning model for banking crises in emerging markets. We perturb our data set many times and create "artificial" samples from which we estimated our model, so that, by construction, it is flexible enough to be applied to new data for out-of-sample prediction. We find that, out of a large number (540) of candidate explanatory variables, from macroeconomic to balance sheet indicators of the countries' financial sector, we can accurately predict banking crises by just a handful of variables. Using data over the period from 1980 to 2010, the model identifies two basic types of banking crises in emerging markets: a "Latin American type", resulting from the combination of a (past) credit boom, a flight from domestic assets, and high levels of interest rates on deposits; and an "Asian type", which is characterized by an investment boom financed by banks' foreign debt. We compare our model to other models obtained using more traditional techniques, a Stepwise Logit, a Classification Tree, and an "Average" model, and we find that our model strongly dominates the others in terms of out-of-sample predictive power.

Paolo Manasse, Roberto Savona, Marika Vezzoli
Keywords: Banking Crises, Early Warnings, Regression and Classification Trees, Stepwise Logit
2013 - n° 480
In the theory of psychological games it is assumed that players' preferences on material consequences depend on endogenous beliefs. Most of the applications of this theoretical framework assume that the psychological utility functions representing such preferences are common knowledge. But this is often unrealistic. In particular, it cannot be true in experimental games where players are subjects drawn at random from a population. Therefore an incomplete-information methodology is called for. We take a first step in this direction, focusing on models of guilt aversion in the Trust Game. We consider two alternative modeling assumptions: (i) guilt aversion depends on the role played in the game, because only the 'trustee' can feel guilt for letting the co-player down, (ii) guilt aversion is independent of the role played in the game. We show how the set of Bayesian equilibria changes as the upper bound on guilt sensitivity varies, and we compare this with the complete-information case. Our analysis illustrates the incomplete-information approach to psychological games and can help organize experimental results in the Trust Game.

Giuseppe Attanasi, Pierpaolo Battigalli and Elena Manzoni
Keywords: Psychological games, Trust Game, guilt, incomplete information
2013 - n° 479
Using personal data collected on the internet, firms and political campaigners are able to tailor their communication to the preferences and orientations of individual consumers and voters, a practice known as hypertargeting. This paper models hypertargeting as selective disclosure of information to an audience with limited attention. We characterize the private incentives and the welfare impact of hypertargeting depending on the wariness of the audience, on the intensity of competition, and on the feasibility of price discrimination. We show that policy intervention that bans the collection of personally identifiable data (for example, through stricter privacy laws requiring user consent) is beneficial when consumers are naive, competition is limited, and firms are able to price discriminate. Otherwise, privacy regulation often backfires.

Florian Hoffmann, Roman Inderst and Marco Ottaviani
Keywords: Hypertargeting, selective disclosure, limited attention, consumer privacy regulation, personalized pricing, competition
2013 - n° 478
Fiscal consolidations achieved by means of spending cuts are much less costly in terms of output losses than tax-based ones. The difference cannot be explained by accompanying policies, including monetary policy, and it is mainly due to the different response of business confidence and private investment. We obtain these results by studying the effects of the adoption of fiscal consolidation plans (rather than isolated shocks), that is combinations of tax increases and spending cuts, some unanticipated, other anticipated, in a sample of 16 OECD economies.

Alberto Alesina, Carlo Favero and Francesco Giavazzi
Keywords: fiscal adjustment, output, confidence, investment
2013 - n° 477
In a model with bankruptcy costs and segmented deposit and equity markets, we endogenize the choice of bank and firm capital structure and the cost of equity and deposit finance. Despite risk neutrality, equity capital is more costly than deposits. When banks directly finance risky investments, they hold positive capital and diversify. When they make risky loans to firms, banks trade off the high cost of equity with the diversification benefits from a lower bankruptcy probability. When bankruptcy costs are high, banks use no capital and only lend to one sector. When these are low, banks hold capital and diversify.

Franklin Allen, Elena Carletti
Keywords: Deposit finance, bankruptcy costs, bank diversification
2013 - n° 476
This paper is structured in three parts. The first part outlines the methodological steps, involving both theoretical and empirical work, for assessing whether an observed allocation of esources across countries is efficient. The second part applies the methodology to the long-run allocation of capital and consumption in a large cross section of countries. We find that countries that grow faster in the long run also tend to save more both domestically and internationally. These facts suggest that either the long-run allocation of resources across countries is inefficient, or that there is a systematic relation between fast growth and preference for delayed consumption. The third part applies the methodology to the allocation of resources across developed countries at the business cycle frequency. Here we discuss how evidence on international quantity comovement, exchange rates, asset prices, and international portfolio holdings can be used to assess efficiency. Overall, quantities and portfolios appear consistent with efficiency, while evidence from prices is difficult to interpret using standard models. The welfare costs associated with an inefficient allocation of resources over the business cycle can be significant if shocks to relative country permanent income are large. In those cases partial financial liberalization can lower welfare.

Jonathan Heathcote, Fabrizio Perri
Keywords: International risk sharing, Long-run risk, Long-run growth, International business cycles, Real exchange rate
2013 - n° 475
This paper characterizes when joint financing of two projects through debt increases expected default costs, contrary to conventional wisdom. Separate financing dominates joint financing when risk-contamination losses (associated to the contagious default of a well-performing project that is dragged down by a poorly-performing project) outweigh standard coinsurance gains. Separate financing becomes more attractive than joint financing when the fraction of returns lost under default increases and when projects have lower mean returns, higher variability, more positive correlation, and more negative skewness. These predictions are broadly consistent with existing evidence on conglomerate mergers, spin-offs, project finance, and securitization.

Albert Banal-Estañol, Marco Ottaviani, Andrew Winton
Keywords: Default costs, conglomeration, mergers, spin-offs, project finance, risk contamination, coinsurance
2013 - n° 474
This paper formulates a general theory of how political unrest influences public policy. Political unrest is motivated by emotions. Individuals engage in protests if they are aggrieved and feel that they have been treated unfairly. This reaction is predictable because individuals have a con sistent view of what is fair. This framework yields novel insights about the sources of political influence of different groups in society. Even if the government is benevolent and all groups have access to the same technology for political participation, equilibrium policy can be distorted. Individuals form their view of what is fair taking into account the current state of the world. If fewer aggregate resources are available, individuals accept a lower level of welfare. This resignation effect in turn induces a benevolent government to procrastinate unpleasant policy choices.
Francesco Passarelli and Guido Tabellini
2013 - n° 473
This paper tests the broadly adopted assumption that people apply a single discount rate to the utility from different sources of consumption. Using unique data from two surveys conducted in rural Uganda including both hypothetical and real choices over different goods, the paper elicits time preferences from approximately 2,400 subjects. The data reject the null of equal discount rates across goods under a number of different modeling assumptions. These results have important theoretical and policy implications. For instance, they provide support for the idea that time-inconsistent behaviors and a corresponding demand for commitment can be observed even if individuals do not exhibit horizon-specific discounting. In addition, good-specific discounting, under certain conditions, can explain the persistence of poverty and low savings by the poor. The paper presents evidence that these conditions are satisfied in the context under study by showing that the share of expenditures on those goods with higher discount rates is decreasing with income.

Diego Ubfal
Keywords: time preferences, self-control problems, good-specific discounting, savings, poverty traps
2013 - n° 472
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
uctuations 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.

Jonathan Heathcote, Fabrizio Perri
Keywords: Country portfolios, International business cycles, Home bias
2013 - n° 471
This paper addresses the following questions. Is there evidence of contagion in the Eurozone? To what extent do sovereign risk and the vulnerability to contagion depend on fundamentals as opposed to a country's 'credibility'? We look at the empirical evidence on EU sovereigns CDS spreads and estimate an econometric model where the crucial role is played by time varying parameters. We model CDS spread changes at country level as reecting three different factors: a Global sovereign risk factor, a European sovereign risk factor and a Financial intermediaries risk factor. Our main ndings are as follows. First, while the US subprime crisis affects all European sovereign risks, the Greek crisis is largely a matter concerning the Euro Zone. Second, differences in vulnerability to contagion in the Eurozone are remarkable: after the Greek crisis the core Eurozone members become less vulnerable to EUZ contagion, possibly due to a safe-heaven effect, while peripheric countries become more vulnerable. Third, market fundamentals go a long way in explaining these differences: they jointly explain between 54 and 80% of the cross-country variation in idiosyncratic risks and in the vulnerability to contagion, largely supporting the 'wake-up calls' hypothesis suggesting that market participats bocome more wary of market fundamentals during finacial crises.
Paolo Manasse, Luca Zavalloni
2013 - n° 470
We consider the problem of selling a firm to a single buyer. The magnitude of the post-sale cash flow rights (v) as well as the benefits of control (b) are the buyer's private information. In contrast to research that assumes the private information of the buyer is one-dimensional, the optimal mechanism is a menu of tuples of cashequity mixtures. We provide sufficient conditions on the joint distribution of v and b such that the optimal mechanism takes one of the following forms: i) a take-it or leave-it offer for the smallest fraction of the company that facilitates the transfer of control, or ii) a take-it or leave-it offer for all the shares of the company. We also identify a sufficient condition for the seller to extract the full value, v, per share so that the buyer earns information rents only on the private benefits of control.

Mehmet Ekmekci, Nenad Kos, Rakesh Vohra
Keywords: Multidimensional mechanism design, negotiated block trades, private benefits, privatization, takeovers, bilateral trade, asymmetric information, cashequity offers
2012 - n° 469
This paper analyses the effect of skilled migration on two measures of innovation, patenting and citations of scientific publications, in a panel of 20 European countries. Skilled migrants positively contribute to the knowledge formation in host countries as they add to the pool of skills in destination markets. Moreover, they positively affect natives' productivity, as new ideas are likely to arise through the interaction of diverse cultures and diverse approaches in problem solving. The empirical findings we present support this prediction. Greater diversity in the skilled professions are associated with higher levels of knowledge creation, measured either by the number of patents applied for through the Patent Cooperation Treaty or by the number of citations to published articles. This finding is robust to the use of different proxies for both the explanatory variables and the diversity index in the labour force. Specifically, we first measure diversity with a novel indicator which uses information on the skill level of foreigners' occupations. We then check our results by following the general literature, which measures skills by looking at the foreigners' level of education. We show that cultural diversity consistently increases the innovation performance of European Countries.

Valentina Bosetti, Cristina Cattaneo and Elena Verdolini
Keywords: cultural diversity, innovation, skilled migration, knowledge production function, Europe
2012 - n° 468
How should a decision-maker assess the potential of an investment when a group of experts provides strongly divergent estimates on its expected payoff? To address this question, we propose and analyze a variant of the well-studied α-maxmin model in decision theory. In our framework, and consistent to the paper's empirical focus on R&D investment, experts' subjective probability distributions are allowed to be action-dependent. In addition, the decision maker constrains the sets of priors to be considered in accordance with ethical considerations and/or operational protocols. Using tools from convex and conic optimization, we are able to establish a number of analytical results including a closed-form expression of our model's value function, a thorough investigation of its differentiability properties, and necessary conditions for optimal investment. We apply our framework to original data from a recent expert elicitation survey on solar technology. The analysis suggests that more aggressive investment in solar technology R&D is likely to yield significant dividends even, or rather especially, after taking ambiguity into account.

Stergios Athanassoglou, Valentina Bosetti, Gauthier de Maere d'Aertryckey
Keywords: expert aggregation; ambiguity; α-maxmin; second-order cone programming; renewable energy R&D
2012 - n° 467
We study optimal taxation of savings in an economy where agents face self-control problems and are allowed to be partially naive. We assume that the severity of self-control problems changes over the life-cycle. We focus on quasihyperbolic discounting with constant elasticity of intertemporal substitution utility functions and linear Markov equilibria. We derive explicit formulas for optimal taxes that implement the efficient allocation. We show that if agents' ability to self-control increases concavely with age, then savings should be subsidized and the subsidy should decrease with age. We also show that allowing for age-dependent self-control problems creates large effects on the level of optimal subsidies, while optimal taxes are not very sensitive to the level of sophistication.

Nicola Pavoni and Hakki Yazici
Keywords: Self-control problems, Linear Markov equilibrium, Life cycle taxation of savings
2012 - n° 466
Several recent papers have proposed recursive Lagrangian-basedmethods for solving dynamic contracting problems. Thesemethods give rise to Bellman operators that incorporate either a dual inf-sup or a saddle point operation. We give conditions that ensure the Bellman operator implied by a dual recursive formulation is contractive.

Matthias Messner, Nicola Pavoni, Christopher Sleet
Keywords: Dynamic Contracts, Duality, Dynamic Programming, Contraction Mapping Theorem
2012 - n° 465
This paper analyses contract cancellation and product return policies in markets in which sellers advise customers about the suitability of their offering. When customers are fully rational, it is optimal for sellers to offer the right to cancel or return on favorable terms. A generous return policy makes the seller's 'cheap talk' at the point of sale credible. This observation provides a possible explanation for the excess refund puzzle and also has implications for the management of customer reviews. When customers are credulous, instead, sellers have an incentive to set unfavorable terms to exploit the inflated beliefs they induce in their customers. The imposition of a minimum statutory standard improves welfare and consumer surplus when customers are credulous. In contrast, competition policy reduces contractual inefficiencies with rational customers, but it is not effective with credulous customers.

Roman Inderst andMarco Ottaviani
Keywords: Cheap talk, advice, marketing, credulity, contract cancellation, refund, return policy, consumer protection
2012 - n° 464
We present a new model of money management, in which investors delegate portfolio management to professionals based not only on performance, but also on trust. Trust in the manager reduces an investor' perception of the riskiness of a given investment, and allows managers to charge higher fees to investors who trust them more. Money managers compete for investor funds by setting their fees, but because of trust the fees do not fall to costs. In the model, 1) managers consistently underperform the market net of fees but investors still prefer to delegate money management to taking risk on their own, 2) fees involve sharing of expected returns between managers and investors, with higher fees in riskier products, 3) managers pander to investors when investors exhibit biases in their beliefs, and do not correct misperceptions, and 4) despite long run benefits from better performance, the profits from pandering to trusting investors discourage managers from pursuing contrarian strategies relative to the case with o trust. We show how trust-mediated money management renders arbitrage less effective, and may help destabilize financial markets.
Nicola Gennaioli, Andrei Shleifer, Robert Vishny
2012 - n° 463
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 generally, the evoked set). 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, context-dependent willingness to pay, and large shifts in demand in response to price shocks.
Pedro Bordalo, Nicola Gennaioli, Andrei Shleifer
2012 - n° 462
We present a model of sovereign debt in which, contrary to conventional wisdom, government defaults are costly because they destroy the balance sheets of domestic banks. In our model, better financial institutions allow banks to be more leveraged, thereby making them more vulnerable to sovereign defaults. Our predictions: government defaults should lead to declines in private credit, and these declines should be larger in countries where financial institutions are more developed and banks hold more government bonds. In these same countries, government defaults should be less likely. Using a large panel of countries, we find evidence consistent with these predictions.

Nicola Gennaioli, Alberto Martin, and Stefano Rossi
Keywords: Sovereign Risk, Capital Flows, Institutions, Financial Liberalization, Sudden Stops
2012 - n° 461
We conduct a geographically and temporally disaggregated empirical analysis of civil conflict at the sub-national level in Africa over the period 1997-2011. Our units of observation are cells of 1 degree of latitude by 1 degree of longitude. We exploit within-year variation in the timing of weather shocks and in the growing season of different crops, as well as spatial variation in crop cover, to construct an original measure of shocks that are relevant for agricultural production. Employing a new drought index we show that negative climate shocks which occur during the growing season of the main crop cultivated in the cell have a sizeable and persistent effect on conflict incidence. We also use state-of-the-art spatial econometric techniques to test for the presence of temporal and spatial spillovers in conflict, and we find both to be sizeable and highly statistically significant. Exploiting variation in the type of conflict episode, we find that the impact of climate shocks on conflict is particularly significant when focusing on outcomes such as battles and violence against civilians. Our estimates can be used to predict how future warming scenarios affect the prevalence and diffusion of conflict.
Mariaflavia Harari and Eliana La Ferrara
2012 - n° 460
I show that labor-tying (being in a labor contract where the employer also acts as an insurance-provider) is an important channel through which the poor in rural Bangladesh insure themselves against risks. Using a theoretical framework adapted from Bardhan (1983), I analyze the effects of an exogenous increase in the outside options of poor women (through an improvement in their self-employment opportunities) on their and their spouses' participation in tied labor, as well as the general equilibrium effects of the treatment on the terms of the labor contracts in the village. I find that treated women and their spouses are less likely to be in tied-labor contracts. Their wages increase through two channels: (a) due to the switch from tied to casual labor contracts (b) through the general equilibrium effects in the village labor market. Furthermore, I find that the treated households form reciprocal transfer links with wealthier households in the village. These findings imply that poor households may be involved in second-best labor contracts to insure themselves against risks. When their self-employment opportunities improve, they break these ties and move to greater reliance on reciprocal transfer arrangements.

Selim Guelsci
Keywords: tied labor, poverty, rural labor market
2012 - n° 459
Recent research emphasizes the importance of information feedback in situations of recurrent decisions and strategic interaction, showing how it affects the uncertainty that underlies selfconfifirming equilibrium (e.g., Battigalli et al. [9, 2015], Fudenberg and Kamada [13, 2015]). Here, we discuss in detail several properties of this key feature of recurrent interaction and derive relationships. This allows us to elucidate our notion of Maxmin selfconfifirming equilibrium, hereby agents are extremely ambiguity averse, and to compare it with the partially-specified-probabilities (PSP) equilibrium of Lehrer [19, 2012]. Symmetric Maxmin selfconfifirming equilibrium in mixed strategies exists under either observable payoffs,or separable feedback.The latter assumption makes this equilibrium concept essentially equivalent to PSP-equilibrium. If observability of payoffs holds as well, then these equilibrium concepts collapse to mixed Nash equilibrium.

P. Battigalli, S. Cerreia-Vioglio, F. Maccheroni, M. Marinacci
Keywords: Selfconfirming equilibrium, conjectural equilibrium, information feedback, ambiguity aversion, partially specified probabilities
2012 - n° 458
Given a functional defi...ned on a nonempty subset of an Archimedean Riesz space with unit, necessary and sufficient conditions are obtained for the existence of a (convex or concave) niveloid that extends the functional to the entire space. In the language of mathematical fi...nance, this problem is equivalent to the one of verifying if the policy adopted by a regulator is consistent with monetary risk measurement, when only partial information is available.
S. Cerreia-Vioglio, F. Maccheroni, M. Marinacci,and A. Rustichini
Keywords: extension theorems, Daniell-Stone theorem, risk measures, variational preferences
2012 - n° 457
Gneezy (2005) reports evidence indicating that in some settings people do not like to lie. In many other situations people do not suffer when they lie. We argue that the theory of simple guilt can accommodate these observations.
Pierpaolo Battigalli, Gary Charness, Martin Dufwenberg
2012 - n° 456
We examine whether the dynamics of the implied volatility surface of individual equity options contains exploitable predictability patterns. Predictability in implied volatilities is expected due to the learning behavior of agents in option markets. In particular, we explore the possibility that the dynamics of the implied volatility surface of individual equity options may be associated with movements in the volatility surface of S&P 500 index options. We present evidence of strong predictable features in the cross-section of equity options and of dynamic linkages between the implied volatility surfaces of equity options and S&P 500 index options. Moreover, time-variations in stock option volatility surfaces are best predicted by incorporating information from the dynamics in the implied volatility surface of S&P 500 index options. We analyze the economic value of such dynamic patterns using strategies that trade straddle and delta-hedged portfolios, and we find that before transaction costs such strategies produce abnormal risk-adjusted returns.

Alejandro Bernales and Massimo Guidolin
Keywords: Equity options; Index options; Implied volatility surface; Predictability; Trading strategies
2012 - n° 455
We systematically assess the recursive performance costs–both ex-ante and ex-post–in recursive real time out-of-sample experiments of implementing diversification strategies that allow occupational investment vehicles (OIVs, like pension funds) to allocate wealth across available assets (equities) by taking into account the presence of regimes and non-stationarities (i.e., structural change in parameters) in the correlation between sector-specific earnings/wages dynamics and stock returns. We find that ex-post, the cost of creating OIVs is negligible and, to the contrary, often negative over our evaluation period: this means that OIVs that exploit and forecast bull and bear regimes end up producing realized performance that are better than those of strategies that do not. The origins of such gains lie in the fact that conditioning on sectorial dynamics, may lead to a more accurate identification and forecasting of regime shifts. Contrary to standard intuition, both ex-ante and ex-post, we find evidence that often an OIV ought to optimally invest in stocks issued either by firms that belong to the same sector that characterizes the OIV or at least from the same country as the OIV.

Massimo Guidolin and Stuart Hyde
2012 - n° 454
The recent crisis has emphasized the role of financial - macroeconomic interactions, and international trade in goods and services, in the transmission of the shocks. Both phenomena, closely related to the higher degree of globalization, are very relevant for small open economies, and particularly so when a large share of the economy relies on financial and distribution services. Hence, in this paper we propose to incorporate the banking and distribution sectors into a medium scale DSGE model of a small open economy. As an illustration, the resulting model is then calibrated to match the specific characteristics of the Luxembourg economy, where the financial sector plays a key role. We believe that the results are also of more general interest for studying the reaction of small open economies to real and financial shocks.

Szabolcs Deák, Lionel Fontagné, Marco Maffezzoli, Massimiliano Marcellino
Keywords: DSGE model, Small open economy, Banking, International trade, Luxembourg, Segmented labor market; Trade union
2012 - n° 453
We study tender offers for a firm which is owned by one large shareholder who holds less than half of the total shares, and many small shareholders who each hold a unit share. Each shareholder is privately informed, yet uncertain, about the raider's ability to improve the value of the firm, whereas the raider is unin- formed. In the benchmark model of complete information, the raider is unable to make a profit. As shown in Marquez and Yılmaz (2008), the same obtains when the raider is facing only privately informed small shareholders. We show, however, that the combination of private information on the side of shareholders and the presence of a large shareholder can facilitate profitable takeovers. More precisely, for any given information structure, the raider can make a profit if the large shareholder holds a sufficiently large stake in the company. In the unique equilibrium outcome, neither the probability of a successful takeover nor the quilibrium price offer depends on the large shareholder's information. Therefore, the large shareholder's information is not reflected in the price. When the equilibrium price offer is positive, the large shareholder tenders all of his shares regardless of his information. Finally, we show that the same type of equilibria arise when there are several large shareholders, as long as their total stake in the company is smaller than one-half.
Mehmet Ekmekci and Nenad Kos
Keywords: takeovers, tender offers, lemons problem, large shareholder
2012 - n° 452
We present an experiment to address the question of whether a piece of information is more influential if it comes from experience, rather than from another source. We employ a novel experimental design which controls for the value of information and other potentially important confounding factors present in related studies. Overall, our results show that an event that is personally experienced has a stronger influence on subsequent behavior than an observed event with equally valuable information content. Importantly, in early rounds when information is more valuable from a rational viewpoint, this overweighting of personal experience is not statistically significant.

Joshua Miller and Zacharias Maniadis
Keywords: Experiments; Learning; Observation; Reinforcement Learning; Belief-Based Learning
2012 - n° 451
The recent financial crises, alongside a dramatic rise in unemployment on both sides of the Atlantic, suggest that financial shocks do translate into the labor markets. In this paper we first document that financial recessions amplify labor market volatility and Okun's elasticity over the business cycle. Second, we highlight a key mechanisms linking financial shocks to job destruction, presenting and solving a simple model of labor market search and endogenous finance. While finance increases job creation and net output in normal times, it also augments their aggregate response in the aftermath of a financial shock. Third, we present evidence coherent with the idea that more leveraged sectors experience larger employment volatility during financial recessions. Theoretically, the job destruction effect of finance works as follows. Leveraged firms may find themselves in a position in which their liquidity is suddenly called back by the lender. This has direct consequences on a firm ability to run and manage e xisting jobs. As a result, firms may be obliged to shut down part of their operations and destroy existing jobs. We argue that with well developed capital markets, firms will have an incentive to rely more on liquidity, and in normal times deep capital markets lead to tight labor markets. After an adverse liquidity shock, firms that rely much on liquidity, are hit disproportionally hard. This may explain why the unemployment rate in the US during the Great Recession increased more than in European countries experiencing larger output losses. Empirically, the paper uses a variety of datasets to test the implications of the model. At first we identify crises that, just like in the model, caused a sudden reduction of liquidity to firms. Next we draw on sector-level data on employment and leverage in a number of OECD countries at quarterly frequencies to assess whether highly leveraged equilibria originate more employment adjustment under financial recessions. We find that highly leveraged sectors and periods are associated with higher employment-to-output elasticities during banking crises and this effect explains the observation of higher Okun's elasticities during financial recessions. We also argue that the effect of leverage on employment adjustment can be interpreted as a causal effect, if our identification assumptions are considered plausible. All this amounts essentially for a test of the labor demand channel of adjustment.

Tito Boeri, Pietro Garibaldi, Espen R. Moen
Keywords: credit squeeze,matching,leverage
2012 - n° 450
This paper studies whether fiscal corrections cause large output losses. We find that it matters crucially how the fiscal correction occurs. Adjustments based upon spending cuts are much less costly in terms of output losses than tax-based ones. Spending-based adjustments have been associated with mild and short-lived recessions, in many cases with no recession at all. Tax-based adjustments have been associated with prolonged and deep recessions. The difference cannot be explained by different monetary policies during the two types of adjustments. Studying the effects of multi-year fiscal plans rather than individual shifts in fiscal variables we make progress on question of anticipated versus unanticipated policy shifts: we find that the correlation between unanticipated and anticipated shifts in taxes and spending is heterogenous across countries, suggesting that the degree of persistence of fiscal corrections varies..Estimating the effects of fiscal lans, rather than individual fiscal shocks, we obtain much more precise estimates of tax and spending multipliers.

Alberto Alesina, Carlo Favero and Francesco Giavazzi
Keywords: fiscal adjustment, output, confidence, investment
2012 - n° 449
Openness per se requires optimal monetary policy to deviate from the canonical closed-economy principle of domestic price stability, even if domestic prices are the only ones to be sticky. I review this argument using a simple partial equilibrium analysis in an economy that trades in ...nal consumption goods. I then extend the standard open economy New Keynesian model to include imported inputs of production. Production openness strengthens even further the incentive for the policymaker to deviate from strict domestic price stability. With both consumption and production openness variations in the world price of food and in the world price of imported oil act as exogenous cost-push factors.

Tommaso Monacelli
Keywords: openness, trade, imported inputs, consumption imports, exchange rate, monetary policy
2012 - n° 448
In an economy with financial imperfections, Ricardian equivalence holds when prices are flexible and the steady-state distribution of consumption is uniform, or labor is inelastic. With different steady-state consumption levels, Ricardian equivalence fails, but tax cuts, somewhat paradoxically, are contractionary; the presentvalue multiplier on consumption is, however, zero. With sticky prices, Ricardian equivalence always fails. A Robin-Hood, revenue-neutral redistribution to borrowers is expansionary on aggregate activity. A uniform cut in taxes financed with public debt has a positive present-value multiplier on consumption, stemming from intertemporal substitution by the savers, who hold the public debt.
Florin Bilbiie, Tommaso Monacelli and Roberto Perotti
2012 - n° 447
We extend the Fundamental Theorem of Finance and the Pricing Rule Representation Theorem of Cox and Ross (see Ross [35] and [37] and Cox and Ross [9]) to the case in which market frictions are aken into account but the Put-Call Parity is still assumed to hold. In turn, we obtain a representation of the pricing rule as a discounted expectation with respect to a nonadditive risk neutral probability. As a further contribution, in so doing we endogenize the state space structure and the contingent claim representation usually assumed to represent assets and markets.

Simone Cerreia-Vioglio, Fabio Maccheroni, Massimo Marinacci
2012 - n° 446
This paper considers the optimal mechanism design problem of an expected revenue maximizing principal who wants to sell a single unit of a good to an agent who is ambiguity averse in the sense of Gilboa and Schmeidler (1989). We show that the optimal static mechanism is an ambiguous mechanism. An ambiguous mechanism specifies a message space and a set of outcome functions. After showing that (a version of) the Revelation Principle holds in our environment, we give an exact characterization of the (smallest) optimal ambiguous mechanism. If the type set is composed of N (finite) types, then the (smallest) optimal ambiguous mechanism contains N - 1 outcome functions. We show that the share of the surplus that the designer can extract from the agent increases as the type set becomes larger and the probability of each single type decreases. In the limiting case where the agent's type is drawn from a non-atomic distribution on an interval, the optimal ambiguous mechanism extracts all the rent from the agent.

Alfredo Di Tillio, Nenad Kos and Matthias Messner
Keywords: Optimal mechanism design, Ambiguity aversion, Incentive compatibility, Individual rationality
2012 - n° 445
Over the last millennium, the clan and the city have been the locus of cooperation in China and Europe respectively. This paper examines - analytically, historically,and empirically - the cultural, social, and institutional co-evolution that led to this bifurcation. We highlight that groups with which individuals identify are basic units of cooperation. Such groups impact institutional development because intra-group moral commitment reduces enforcement cost implying a comparative advantage in pursuing collective actions. Moral groups perpetuate due to positive feedbacks between morality, institutions, and the implied pattern of cooperation.
Avner Greif and Guido Tabellini
2012 - n° 444
We develop a theory of corporate boards and their role in forcing CEO turnover. We consider a firm with an incumbent CEO of uncertain management ability and a board consisting of a number of directors whose role is to evaluate the CEO and fire her if a better replacement can be found. Each board member receives an independent private signal about the CEO's ability, after which board members vote on firing the CEO (or not). If the CEO is fired, the board hires a new CEO from the pool of candidates available. The true ability of the rm's CEO is revealed in the long run; the firm's long-run share price is determined by this ability. Each board member owns some equity in the firm, and thus prefers to fire a CEO of poor ability. However, if a board member votes to fire the incumbent CEO but the number of other board members also voting to fire her is not enough to successfully oust her, the CEO can impose significant costs of dissent on him. In this setting, we show that the board faces a coordination problem, leading it to retain an incompetent CEO even when a majority of board members receive private signals indicating that she is of poor quality. We solve for the optimal board size, and show that it depends on various board and rm characteristics: one size does not fit all firms. We develop extensions to our basic model to analyze the optimal composition of the board between firm insiders and outsiders and the effect of board members observing imprecise public signals in addition to their private signals on board decision-making. Finally, we develop a dynamic extension to our basic model to analyze why many boards do not fire CEOs even when they preside over a signi cant, publicly observable, reduction in shareholder wealth over a long period of time. We use this dynamic model to distinguish between the characteristics of such boards from those that fire bad CEOs proactively, before significant shareholder wealth reductions take place.
Thomas J. Chemmanur and Viktar Fedaseyeu
2012 - n° 443
We investigate the role of government-provided loans on market outcomes. First, we show that government-provided financing can lead to asset bubbles when enough households have adaptive expectations and determine the minimum share of households with adaptive expectation that is sufficient for bubbles to arise. Second, we show that in addition to causing bubbles government-provided loans can generate a propagation mechanism behind them. Third, we show that bubbles can be avoided if financing is provided over a sufficiently large number of periods rather than all at once, even when households have adaptive expectations.

Viktar Fedaseyeu and Vitaliy Strohush
Keywords: Asset bubbles, government-provided loans
2012 - n° 442
I examine the role of third-party debt collectors in consumer credit markets. Using law enforcement as an instrument for the number of debt collectors, I find that higher density of debt collectors increases the supply of unsecured credit. The estimated elasticity of the average credit card balance with respect to the number of debt collectors per capita is 0.49, the elasticity of the average balance on non-credit card unsecured loans with respect to the number of debt collectors per capita is 1.32. I also find evidence that creditors substitute unsecured credit for secured credit when the number of debt collectors increases. Higher density of debt collectors improves recoveries, which enables lenders to extend morecredit. Finally, creditors charge higher interest rates and lend to a larger pool of borrowers when the density of debt collectors increases, presumably because better collections enable them to extend credit to riskier applicants.

Viktar Fedaseyeu
Keywords: household finance, consumer credit, lender protection, cre ditor rights, debt collection
2012 - n° 441
In this paper, we show that secondary buyouts (SBOs) do not generate a signifi...cant improvement in the operating performance of target companies. We collect deal-level infor mation on 2,911 buyouts between 1998 and 2008 and gather detailed firm-level financial and accounting information on 163 companies targeted by two consecutive leveraged acquisitions in the period 1998-2008. We show that ...first-round buyers generate a large and signi...cant ab normal improvement in operating performance and efficiency. In contrast, SBO investors do not show statistically signi...cant evidence of incremental contribution to the performance oftarget companies whereas they increasing leverage and squeeze-out. Returns to PE investors are signifi...cantly lower in secondary transactions and are mostly determined by large dividend payments. Market-wide SBO activity is signifi...cantly determined by favorable debt market conditions and PE reputation. Additionally, large and high-value deals are more likely to be exited through an SBO. We test a possible collusive motive for this class of deals, fo...nding some support for this conjecture.

Stefano Bonini
Keywords: Secondary buyout, Private Equity, Financial Crisis
2012 - n° 440
We use response time (RT) and behavioral data from two different but related games to test the hypothesis that individuals use introspection when confronted with a new strategic situation. Our results confirm that the need to reflect about the possible behavior of the other player (interactive thought) has an important role in the mental processes present in strategic interactions. We also find that players with longer response times have distributions of behavior that are more dispersed than for faster players. This suggests that the longest RTs across games correspond to thought dedicated to the resolution of moral dilemmas and not to guessing the likely behavior of other players in order to maximize own payoff.
Pablo Branas-Garza, Debrah Meloso andLuis Miller
2012 - n° 439
This paper estimates the impact of longevity risk on pension systems by combining the prediction based on a Lee-Carter (1992) mortality model with the projected pension payments for different cohorts of retirees. We measure longevity risk by the difference between the upper bound of the total old-age pension expense and its mean estimate. This difference is as high as 4 per cent of annual GDP over the period 2040-2050. The impact of longevity risk is sizeably reduced by the introduction of indexation of retirement age to expected life at retirement. Our evidence speaks in favour of a market for longevity risk and calls for a closer scrutiny of the potential redistributive effects of longevity risk.

Emilio Bisetti and Carlo A. Favero
Keywords: stochastic mortality, longevity risk, social security reform
2012 - n° 438
We develop a new theory of delegated investment whereby managers compete in terms of composition of the portfolios they promise to acquire. We study the resulting asset pricing in the inter-manager market. We incentivize investors so that we obtain sharp predictions. Managers are paid a fixed fraction of fund size. In equilibrium, investors choose managers who offer portfolios that mimic Arrow-Debreu (state) securities. Prices in the inter-manager market are predicted to satisfy a weak version of the CAPM: state-price probability ratios implicit in prices of traded assets decrease in aggregate wealth across states. An experiment involving about one hundred participants over six weeks broadly supports the theoretical predictions. Pricing quality declines, however, when fund concentration increases because funds flow towards managers who offer portfolios closer to Arrow-Debreu securities (as in the theory) and who had better recent performance (an observation unrelated to the theory).
Elena Asparouhova, Peter Bossaerts, Jernej Copic, Brad Cornell, Jaksa Cvitanic, Debrah Meloso
2012 - n° 437
We propose a simple theory of predatory pricing, based on incumbency advantages, scale economies and sequential buyers (or markets). The prey needs to reach a critical scale to be successful. The incumbent (or predator) has an initial advantage and is ready to make losses on earlier buyers so as to deprive the prey of the scale the latter needs, thus making monopoly profits on later buyers. Several extensions are considered, including cases where scale economies exist because of demand externalities or two-sided market e ects, and where markets are characterized by common costs. Conditions under which predation may (or not) take place in actual cases are also discussed.
Chiara Fumagalli and Massimo Motta
2012 - n° 436
This paper estimates the effect of employment protection legislation (EPL) on workers' individual wages in a quasi-experimental setting, exploiting a reform that introduced unjust-dismissal costs in Italy for firms below 15 employees and left firing costs unchanged for bigger firms. Accounting for the endogeneity of the treatment status, we find that the slight average wage reduction (between -0:4 and -0:1 percent) that follows the increase in EPL hides highly heterogeneous effects. Workers who change firm during the reform period suffer a in the entry wage, while incumbent workers are left unaffected. Results also indicate that the negative wage effect of the EPL reform is stronger on young blue collars and on workers at the low-end of the wage distribution. Finally, workers in low-employment regions suffer higher wage reductions after the reform. This pattern suggests that the ability of the employers to shift EPL costs onto wages depends on workers' and firms' relative bargaining power.

Marco Leonardi and Giovanni Pica
Keywords: Cost of Unjust Dismissals, Severance Payments, Policy Evaluation, Endogeneity of Treatment Status
2012 - n° 435
The effects of public debt and redistribution are intimately related. We illustrate this in a model with heterogenous agents and imperfect credit markets. Our setup differs from the classic Savers-Spenders model of fiscal policy in that all agents engage in intertemporal optimization, but a fraction of them is subject to a borrowing limit. We show that, despite the credit frictions, Ricardian equivalence holds under flexible prices if the steady-state distribution of wealth is degenerate: income effects on labor supply deriving from a tax redistribution are entirely symmetric across agents. When the distribution of wealth is non-degenerate, a tax cut is, somewhat paradoxically, contractionary. Conversely, sticky prices generate empirically plausible deviations from Ricardian equivalence, even in the case of degenerate wealth distribution. A revenue-neutral redistribution from unconstrained to constrained agents is expansionary, while debt...nanced tax cuts have effects that go beyond their redistributional component: the present-value multiplier of a tax cut is positive due to an interplay of intertemporal substitution by those who hold the public debt and income effects on those who do not.
Florin Bilbiie, Tommaso Monacelli, Roberto Perotti
2012 - n° 434
We study the interaction between a firm that invests in research and, if successful, undertakes a practice to exploit the innovation, and an enforcer that sets legal standards, fines and accuracy. In innovative industries deterrence on actions interacts with deterrence on research. A per-se legality rule prevails when the practice increases expected welfare, moving to a discriminating rule combined with type-I accuracy for higher probabilities of social harm. Moreover, discriminating rules should be adopted more frequently in traditional industries than in innovative environments; patent and antitrust policies are substitutes; additional room for per-se (illegality) rules emerges when fines are bounded.

Giovanni Immordino and Michele Polo
Keywords: legal standards, accuracy, antitrust, innovative activity, enforcement
2012 - n° 433
We give a general integral representation theorem (Theorem 6) for nonadditive functionals de...ned on an Archimedean Riesz space X with order unit. Additivity is replaced by a weak form of modularity, or equivalently dual comonotonic additivity, and integrals are Choquet integrals. Those integrals are de...ned through the Kakutani [8] isometric identi...cation of X with a C (K) space. We further show that our novel notion of dual comonotonicity naturally generalizes and characterizes the notions of comonotonicity found in the literature when X is assumed to be a space of functions.
Simone Cerreia-Vioglio, Fabio Maccheroni, Massimo Marinacci,Luigi Montrucchio
2012 - n° 432
This paper argues that a stable broad money demand for the euro area over the period 1980-2011 can be obtained by modelling cross border international portfolio allocation. As a consequence, model-based excess liquidity measures, namely the difference between actual M3 growth (net of the inflation objective) and the expected money demand trend dynamics, can be useful to predict HICP inflation.

Roberto A. De Santis, Carlo A. Favero and Barbara Roffia
Keywords: Euro area money demand, inflation forecasts, monetary policy, portfolio allocation
2012 - n° 431
Unstability in the comovement among bond spreads in the euro area is an important feature for dynamic econometric modelling and forecasting. This paper proposes a non-linear GVAR approach to spreads in the euro area where the changing interdepence among these variables is modelled by making each country spread function of a global variable determined by fiscal fundamentals with a time-varying composition. The model naturally accommodates the possibility of multiple equilibria in the relation between default premia and local fiscal fundamentals. The estimation reveals a significant non-linear relation between spreads and fiscal fundamentals that generates time-varying impulse response of local spreads to shocks in other euro area countries spreads. The GVAR framework is then applied to the analysis of the dynamic effects of fiscal stabilization packages on the cost of government borrowing and to the evaluation of the importance of potential contagion effects determining a significant increase in cross-market linkages after a shock to a group of countries.

Carlo A. Favero
Keywords: non-linear Global VAR, Bond Spreads in the euro-area, time-varying interdependence, contagion
2011 - n° 430
As governments around the world contemplate slashing budget deficits, the "expansionary fiscal consolidation hypothesis" is back in vogue. I argue that, as a statement about the short run, it should be taken with caution. Alesina and Perotti (1995) and Alesina and Ardagna (2010) (AAP) have argued that, contrary to conventional wisdom, fiscal consolidations may be expansionary if implemented mainly by cutting government spending. IMF (2010) criticizes the data used by AAP and shows that all consolidations are contractionary in the short run. I argue that this criticism is correct in principle, and that there are other important limitations in the AAP methodology. However, the implementation of the IMF methodology has several problems of its own, that make an interpretation of the IMF results difficult. I then argue that because of the multi-year nature of the large fiscal consolidations, which are precisely those that can tell us more on the mechanisms at work, using yearly panels of annual data is limiting. I present four detailed case studies of fiscal consolidations, two (Denmark and Ireland) carried out under fixed exchange rates (arguably the most relevant case for many European countries today) and two (Finland and Sweden) after floating the currency. All four consolidations were associated with an expansion; but only in Denmark the driver of growth was internal demand. However, as in most exchange rate based stabilizations, after three years a long slump set in as the economy lost competitiveness. In the other episodes for a long time the main driver of growth was exports. In the second exchange rate based stabilization, Ireland, this occurred because the sterling coincidentally appreciated. In Finland and Sweden the currency experienced an extremely large depreciation after floating. In all consolidations interest rate fell fast, and wage moderation played a key role in ensuring competitiveness and allowing the decrease in interest rates. Wage moderation was supported by incomes policies that saw the direct in tervention of the government in the wage negotiation process. These results cast doubt on at least some versions of the "expansionary fiscal consolidations" hypothesis, and on its applicability to many countries in the present circumstances. A depreciation is not available to EMU members today (except vis a vis countries outside the Eurozone). The current account channel is not available to the world as a whole. A further decline in interest rates is unlikely in the current situation. And incomes policies are not popular nowadays; moreover, international experience, and the Danish case, suggest that they are ineffective after a few years.


Roberto Perotti
2011 - n° 429
With fiscal foresight, the shocks identified by standard Vector Autoregression (SVAR) techniques can be non-fundamental for the variables of interest. In an important paper, Ramey (2011) uses direct measures of the private sector's forecast revisions of defense or federal spending to estimate the effects of government spending shocks in a VAR, obtaining the 'expectations - augmented' VAR, or EVAR. The response of GDP to these shocks is smaller than 1, and consumption and the real wage fall: this is consistent with the neoclassical model, but the opposite of recent results from SVARs. In this paper, I make three points. First, EVARs and SVARs give virtually the same results. Ramey reaches the opposite conclusion because she never estimates the two specifications on the same sample and with the same government spending variable. Second, the evidence from EVARs is not robust. It is enough to dummy out just two quarters during WWII (when rationing was introduced) or during the Korean War (when new Fed regulation di couraging the purchase of durables was introduced) for the negative effects of defense spending shocks to disappear. Third, the forecast revision of federal spending from the Survey of Professional Forecasters has high explanatory power for government spending, but for the 'wrong' reason: the predictive power of expected government spending growth is extremely low, so that the forecast error is effectively actual spending growth less noise.

Roberto Perotti
Keywords: Government Spending, Vector Autoregressions, Fiscal Multiplier
2011 - n° 428
We propose to bring together two conceptually complementary ideas: (1) selfconfirming equilibrium (SCE): at rest points of learning dynamics in a game played recurrently, agents best respond to confirmed beliefs, i.e., beliefs consistent with the evidence they accumulated, and (2) ambiguity aversion: agents, other things being equal, prefer to bet on events with known rather than unknown probabilities and, more generally, distinguish objective from subjective uncertainty, a behavioral trait captured by their ambiguity attitudes. Using as a workhorse the 'smooth ambiguity' model of Klibanoff, Marinacci and Mukerji (2005), we provide a definition of 'Smooth SCE' which generalizes the traditional concept of Fudenberg and Levine (1993a,b), here called Bayesian SCE, and admits Waldean (maxmin) SCE as a limit case. We show that the set of equilibria expands as ambiguity aversion increases. The intuition is simple: by playing the same strategy in a stable state an agent learns the implied objective probabilities of payoffs, but alternative strategies yield payoffs with unknown probabilities; keeping beliefs fixed, increased aversion to ambiguity makes such strategies less appealing. In sum, by combining the SCE and ambiguity aversion ideas a kind of 'status quo bias' emerges: in the long run, the uncertainty related to tested strategies disappears, but the uncertainty implied by the untested ones does not. We rely on this core intuition to show that different notions of equilibrium are nested in a simple way, from finer to coarser: Nash, Bayesian SCE, Smooth SCE and Waldean SCE. We also prove some equivalence results under special assumptions about the information structure.

Pierpaolo Battigalli, Simone Cerreia-Vioglio, Fabio Maccheroni and Massimo Marinacci
Keywords: Selfconfirming equilibrium, conjectural equilibrium, uncertainty, smooth ambiguity
2011 - n° 426
The current account has always been a neglected variable in the management of the Euro area and in the assessment of its members' performance; so has, as a consequence, the savings-investment balance. This paper first reviews the arguments that explain this attitude and justify, under some conditions and in some cases, the persistence of current account deficits. It then examines some peculiar features of the growth experience under monetary union in four Euro area countries which do not conform to the conventional convergence pattern. Models establishing the optimality of a succession of current account deficits in a catching-up process implicitly assume that the intertemporal budget constraint is satisfied, so that the accumulation of foreign liabilities is matched by future surpluses. In section 3 we first introduce explicitly this constraint in a simple two-period, two-good model and show that its fulfilment requires that growth be driven by an adequate increase of the country's production capacity of traded goods and services. By examining the composition of output and demand we show that this has not been the case in the four countries considered and argue that monetary union has helped relax the necessary discipline. The common monetary policy moreover did nothing to prevent an extraordinary growth of credit that fed the imbalances in the four countries. The paper closes addressing some policy issues related to the future sustainability o the monetray union.


Francesco Giavazzi and Luigi Spaventa
2011 - n° 425
Financial systems are inherently fragile because of the very function which makes them valuable: liquidity transformation. Thus regulatory reforms, as urgent and desirable as they are, will definitely strengthen the financial system and decrease the risk of liquidity crises, but they will never eliminate it. This leaves monetary policy with a very important task. In a framework that recognizes the interactions between monetary policy and liquidity transformation 'optimal' monetary policy would consist of a modified Taylor rule in which the real rate reflects the possibility of liquidity crises and recognizes the possibility that liquidity transformation gets ubsidized. Failure to recognize this point risks leading the economy into a low interest rate trap: low interest rates induce too much risk taking and increase the probability of crises. These crises, in turn, require low interest rates to maintain the ...nancial system alive. Raising rates becomes extremely difficult in a severely weakened financial system, so monetary authorities remain stuck in a low interest rates trap. This seems a reasonable description of the situation we have experienced throughout the past decade.


Francesco Giavazzi and Alberto Giovannini
2011 - n° 424
In this paper, we provide new evidence on the determinants of sovereign yield spreads and contagion effects in the euro area in order to evaluate the rationale for a common Eurobond jointly guaranteed by euro-area Member States. We find that default risk is the main driver of yield spreads, suggesting small gains from greater liquidity. Fiscal fundamentals matter in the pricing of default risk but only as they interact with other countries' yield spreads; i.e. with the global risk that the market perceives. More important, the impact of this global risk variable is not constant over time, a clear sign of contagion driven by shifts in market sentiment. This evidence points to a discontinuity in the disciplinary role of financial markets. If markets can stay irrational longer than a country can stay solvent, then the role of yield spreads on national bonds as a fiscal discipline device is considerably weakened, and issuing Eurobonds can be economically justified.


Carlo Favero, Alessandro Missale
2011 - n° 423
We bring together the theories of duality and dynamic programming. We show that the dual of an additively separable dynamic optimization problem can be recursively decomposed using summaries of past Lagrange multipliers as state variables. Analogous to the Bellman decomposition of the primal problem, we prove equality of values and solution sets for recursive and sequential dual problems. In non-additively separable settings, the equivalence of the recursive and sequential dual is not guaranteed. We relate recursive dual and recursive primal problems. If the Lagrangian associated with a constrained optimization problem admits a saddle then, even in non-additively separable settings, the values of the recursive dual and recursive primal problems are equal. Additionally, the recursive dual method delivers necessary conditions for a primal optimum. If the problem is strictly concave, the recursive dual method delivers necessary and sufficient conditions for a primal optimum. When a saddle exists, states on the optimal dual path are subdifferentials of the primal value function evaluated at states on the optimal primal path and vice versa.


Matthias Messner, Nicola Pavoni, Christopher Sleet
2011 - n° 422
Banks provide credit and take deposits. Whereas a high price in the credit market increases banks' retained earnings and attracts more deposits, it reduces lending if borrowers are sufficiently poor to be tempted by diversion. Thus optimal bank market structure trades off the benefits of monopoly banking in attracting deposits against losses due to tighter credit. The model shows that market structure is irrelevant if both banks and borrowers lack resources. Monopoly banking induces tighter credit rationing if borrowers are poor and banks are wealthy, and increases lending if borrowers are wealthy and banks lack resources. The results indicate that improved legal protection of creditors is a more efficient policy choice than legal protection of depositors, and that subsidies to firms lead to better outcomes than subsidies to banks. There are also likely to be sizable gains from promoting bank competition in developing countries.


Andreas Madestam
2011 - n° 421
We build a model where a dark pool is introduced to a transparent limit order book market. We show that orders are diverted to the dark pool, but more orders are also executed so total volume increases especially when the order book is shallow. A smaller spread, greater depth and larger tick size stimulate order migration to the dark pool. Institutional traders always benefit from having access to the dark pool. Market quality and retail traders' welfare deteriorate when the order book is shallow, but improve when it is deep. These effects are stronger for a continuous than for a periodic dark pool. If pre-trade transparency is required, the effects on market quality and retail traders' welfare are magnified if the dark pool executes periodically but do not change significantly if the dark pool is continuous.


Sabrina Buti, Barbara Rindi, Ingrid M. Werner
2011 - n° 420
A dominant firm undertakes a given business practice that is regulated by an antitrust enforcer by the choice of a legal standard, fines and accuracy. In traditional industries the incumbent and technology are already established, while in innovative industries the successful innovator becomes dominant. In the former case, marginal deterrence is key to enforcement, and discriminating rules are always dominant when fines are unbounded, or they are replaced with per-se illegality when fines are capped and the practice is likely to be socially harmful. In innovative industries marginal deterrence interacts with average deterrence (the impact of enforcement on innovation eort). Then, per-se legality is preferred when the practice is likely to be welfare beneficial, moving to a discriminating rule when social harm becomes more likely. When fines are capped, per se-legality, discriminating rule and per-se illegality are alternatively chosen when the practice is more and more likely to be socially harmful.

Giovanni Immordino, Michele Polo
Keywords: legal standards, accuracy, antitrust, innovative activity, enforcement
2011 - n° 419
We build an agent-based simulation model that incorporates both historical data on population characteristics and spatial information on the geography of France to experimentally study the role of social interactions in fertility decisions. We assess how different behavioural and interdependence assumptions cause variations in macro dynamics and diffusion patterns. The analyses show that incorporating social interactions into the model contribute to mimic empirically observed behaviour. Our findings suggest individual-level mechanisms through which the observed demographic transition was materialised.

Sandra González-Bailón andTommy E. Murphy
Keywords: fertility decline, demographic transition, diffusion, France, simulation experiments, agent-based models, decision-making, social norms, social interactions
2011 - n° 418
We analyze the effect of means-tested benefits on annuitization decisions. Most industrialized countries provide a subsistence level consumption floor in old age, usually in the form of means-tested benefits. The availability of such means-tested payments creates an incentive to cash out (occupational) pension wealth for low and middle income earners, instead of taking the annuity. Agents trade-off the advantages from annuitization, receiving the wealth-enhancing mortality credit, to the disadvantages, giving up "free" wealth in the form of means-tested supplemental benefits. We find that the availability of means-tested benefits can reduce the desired annuitization levels substantially. Using individual level data, we show that the model's predicted annuitization rates as a function of the level of pension wealth are roughly consistent with the cash-out patterns of occupational pension wealth observed in Switzerland.

Monika Bϋtler, Kim Peijnenburg, Stefan Staubli
Keywords: Means-Tested Benefits, Occupational Pension, Annuity, Life-cycle Model
2011 - n° 417
Empirical research suggests that investors' behavior is not well described by the traditional paradigm of (subjective) expected utility maximization under rational expectations. A literature has arisen that models agents whose choices are consistent with models that are less restrictive than the standard subjective expected utility framework. In this paper we survey the literature that has explored the implications of decision-making under ambiguity for financial market outcomes, such as portfolio choice and equilibrium asset prices. We conclude that the ambiguity literature has led to a number of significant advances in our ability to rationalize empirical features of asset returns and portfolio decisions, such as the failure of the two-fund separation theorem in portfolio decisions, the modest exposure to risky securities observed for a majority of investors, the home equity preference in international portfolio diversification, the excess volatility of asset returns, the equity premium and the risk-free r ate puzzles, and the occurrence of trading break-downs.

JEL codes: G10, G18, D81.

Massimo Guidolin, Francesca Rinaldi
Keywords: ambiguity, ambiguity-aversion, participation, liquidity, asset pricing
2011 - n° 416
This paper uses a multi-factor pricing model with time-varying risk exposures and premia to examine whether the 2003-2006 period has been characterized, as often claimed by a number of commentators and policymakers, by a substantial missprcing of publicly traded real estate assets (REITs). The estimation approach relies on Bayesian methods to model the latent process followed by risk exposures and idiosynchratic volatility. Our application to monthly, 1979-2009 U.S. data for stock, bond, and REIT returns shows that both market and real consumption growth risks are priced throughout the sample by the cross-section of asset returns. There is weak evidence at best of structural misspricing of REIT valuations during the 2003-2006 sample.

Massimo Guidolin, Francesco Ravazzolo, Andrea Donato Tortora
Keywords: REIT returns, Bayesian estimation, Structural instability, Stochastic volatility, Linear factor models
2011 - n° 415
I review the burgeoning literature on applications of Markov regime switching models in empirical finance. In particular, distinct attention is devoted to the ability of Markov Switching models to fit the data, filter unknown regimes and states on the basis of the data, to allow a powerful tool to test hypothesesformulated in the light of financial theories, and to their forecasting performance with reference to both point and density predictions. The review covers papers concerning a multiplicity of sub-fields in financial economics, ranging from empirical analyses of stock returns, the term structure of default-free interest rates, the dynamics of exchange rates, as well as the joint process of stock and bond returns.

Massimo Guidolin
Keywords: Markov switching, Regimes, Regime shifts, Nonlinearities, Predictability, Autoregressive Conditional Heteroskedasticity
2011 - n° 414
It is often suggested that through a judicious choice of predictors that track business cycles and market sentiment, simple Vector Autoregressive (VAR) models could produce optimal strategic portfolio allocations that hedge against the bull and bear dynamics typical of financial markets. However, a distinct literature exists that shows that nonlinear econometric frameworks, such as Markov switching (MS), are also natural tools to compute optimal portfolios in the presence of stochastic good and bad market states. In this paper we examine whether simple VARs can produce portfolio rules similar to those obtained under MS, by studying the effects of expanding both the order of the VAR and the number/selection of predictor variables included. In a typical stock-bond strategic asset allocation problem, we compute the out-of-sample certainty equivalent returns for a wide range of VARs and compare these measures of performance with those typical of nonlinear models for a long-horizon investor with constant relative risk aversion. We conclude that most VARs cannot produce portfolio rules, hedging demands, or (netof transaction costs) out-of-sample performances that approximate those obtained from equally simple nonlinear frameworks. We also compute the improvement in realized performance that may be achieved adopting more complex MS models and report this may be substantial in the case of regime switching ARCH.

Massimo Guidolin and Stuart Hyde
2011 - n° 413
We provide a bridge between Bewley preferences [2] and Uncertainty averse preferences [4]. In doing this, we generalize the findings of Gilboa, Maccheroni, Marinacci, and Schmeidler [11]. To exemplify this new framework, we then study a class of preferences that we call Constrained Multiplier preferences and that was first proposed by Wang [19].


Simone Cerreia-Vioglio
2011 - n° 412
This article documents and examines the integration of grain markets in Europe across the early modern/late modern divide and across distances and regions. It relies on principal component analysis to identify market structures. The analysis finds that a European market emerged only in the nineteenth century, but the process had earlier roots. In early modern times a fall in trading costs was followed by an increase in market efficiency. Gradually expanding processes of integration unfolded in the long-run. Early modern regional integration was widespread but uneven, with North-Western Europe reaching high levels of integration at a particularly early stage. Low-land European markets tended to be larger and better integrated than in land-locked Europe, especially within large, centralised states. In the nineteenth century, national markets grew in old states, but continental and domestic dynamics had become strictly linked.

David Chilosi, Tommy E. Murphy and Roman Studer
Keywords: International and Domestic Trade, Transport costs, Geography, Economic Integration, Grain Markets, Factor Analysis, Europe, Pre-1913
2011 - n° 411
We exploit the quasi-random assignment of borrowers to loan officers using data from a large Albanian lender to show that own-gender preferences affect both credit supply and demand. Borrowers matched to officers of the opposite sex are less likely to return for a second loan. The effect is larger when officers have little prior exposure to borrowers of the other gender and when they have more discretion to act on their gender beliefs, as proxied by financial market competition and branch size. We examine one channel of influence, loan conditionality. Borrowers assigned to opposite-sex officers pay higher interest rates and receive lower loan amounts, but do not experience higher arrears. Our results imply that own-gender preferences in the credit market can have substantial negative welfare effects.

Thorsten Beck, Patrick Behr and Andreas Madestam
Keywords: Group identity, gender, credit supply, credit demand, loan officers
2011 - n° 410
We find that Epstein (2010)'s Ellsberg-style thought experiments pose, contrary to his claims, no paradox or difficulty for the smooth ambiguity model of decision making under uncertainty developed by Klibanoff, Marinacci and Mukerji (2005). Not only are the thought experiments naturally handled by the smooth ambiguity model, but our reanalysis shows that they highlight some of its strengths compared to models such as the maxmin expected utility model (Gilboa and Schmeidler (1989)). In particular, these examples pose no challenge to the model's foundations, interpretation of the model as affording a separation of ambiguity and ambiguity attitude or the potential for calibrating ambiguity attitude in the model.


Peter Klibanoff, Massimo Marinacci andSujoy Mukerji
2011 - n° 409
During a fiscal stimulus, does it matter, for the size of the government spending multiplier, which category of agents bears the brunt of the current and/or future adjustment in taxes? In an economy with heterogeneous agents and imperfect financial markets, the answer depends on whether or not New Keynesian features, such are price rigidity, are present. If prices are flexible, the tax-financing rule is either neutral or quasi-neutral. If prices are sticky, who bears the brunt of the adjustment, whether financially constrained borrowers as opposed to unconstrained savers, does matter. The differential effect on the multiplier, however, depends crucially on (i) the degree of persistence of the fiscal expansion, and (ii) on whether the expansion is balanced-budget as opposed to debt-financed.


Tommaso Monacelli and Roberto Perotti
2011 - n° 408
With perfect credit markets, any (lump-sum) tax redistribution is neutral. We study the eects of a tax redistribution in an economy with heterogenous agents and borrowing constraints. Under flexible prices, a tax redistribution that favors 'the poor' (i.e., the credit constrained) is neutral, or, possibly, even mildly contractionary. When nominal prices are sticky, that result is overturned: a tax redistribution from the savers to the constrained borrowers is expansionary on output. Key to the non-neutrality result is the agents' heterogenous sensitivity to movements in the credit premium.

Tommaso Monacelli and Roberto Perotti