High Leverage and Willingness to Pay: Evidence from the Residential Housing Market

I document a strong correlation between paying the full listing price on homes and borrowing 100% loan‐to‐value. Homebuyers who do both overpay by 2.8% to 3.9% ($4,800 to $6,700) and are 22.7% more likely to have their properties foreclosed within one year. The correlation is not mechanical: there is a discontinuity in the average leverage around the full listing price. The correlation is stronger in areas with a high fraction of financially constrained and unsophisticated residents, and in areas of high past price growth (potentially indicative of buyer optimism).     

Subsidizing heterogeneous higher education systems

In many countries, there is an ongoing debate on the public funding of the higher education (HE) system. Our goal is to examine the theoretical justification for the establishment of HE institutions and analyze the self-selection of students under different policies of student subsidies. We study nonstationary equilibria of an overlapping-generation economy in a hierarchical education system. Given the capacity constraints of Universities, we explore the impact of adding new institutions, to be called Colleges, to the HE system, focusing on three issues. Given that Colleges are less productive and less selective than Universities: (a) Should the government establish Colleges? (b) Should the government divert funds from Universities to Colleges? On the basis of long-run economic growth considerations, we obtain positive answers to both questions. (c) Then, we compare several policies of student subsidies across the board. Our results suggest that much caution is needed in the implementation of student subsidies. Specifically, targeting subsidies to the highly-ranked students in each institution may distort their self-selection across institutions and downgrade the human capital accumulation in the economy. To offset this distortion in the demand for HE it may be useful to target subsidies to the low-ranked students in each institution. Our model also accounts for several stylized facts over time: (1) the increase in the number of institutions and students, (2) the decline in College admission standards, and (3) the decline in public budget per student and the corresponding increase in out-of-pocket student payments.     

Experimental Tests of Self-Selection and Screening in Insurance Decisions

A major characteristic of insurance markets is information asymmetry that may lead to phenomena such as adverse selection and moral hazard. Another aspect of markets with asymmetric information is self-selection, which refers to the pattern of choices that individuals with different personal characteristics make when facing a menu of contracts or options. To combat problems of asymmetric information, insurance firms can use screening. That is, they can offer the clients a menu of choices and infer their characteristics from their choices.This article reports the results of several studies that examined the degree to which people behave according to the notions of self-selection and screening. Subjects played the role of either insurance buyers or sellers. The results of these studies provide partial support for the hypothesis that subjects use self-selection and screening in insurance markets. Our study also points at the importance of learning in experimental studies. In one-stage experiments where subjects did not get feedback, screening was not detected. When multistage experiments were conducted, and the subjects learned from experience and were also taught the relevant theories, their decisions were more aligned with screening.     

Cumulative Discrete Choice

We present a discrete choice model in which a consumer's impression of each alternative is based on her memory of past experience with this choice, and is stochastically updated whenever the alternative is chosen. The consumer remembers a cumulative utility index per alternative, and, when an alternative is chosen, the index is updated by the addition of a random variable, interpreted as instantaneous utility. We prove that the frequencies of choice converge, with probability 1, to limit frequencies, which can be computed from the model's parameters.     

Optimal steady-state in stationary consumption-loan type models

We consider a stationary overlapping generations economy, and prove that an optimal steady state exists. We show that if a government intervention is needed in order to implement the optimal steady state as a competitive equilibrium, it is necessary only in a finite number of periods. If the interest rate associated with the optimal steady state equals the population rate of growth, some outside money may be required in order to make the competitive equilibrium follow the optimal steady state. We show that our existence result enables us to construct Pareto optimal competitive equilibria in some important cases.     

PARTIAL EXERCISE OF LOAN COMMITMENTS UNDER ADAPTIVE PRICING

The partial takedown phenomenon associated with bank loan commitments is examined in a dynamic context in which banks adjust commitment prices to client takedown behavior. The optimal takedown is an increasing function of client riskiness and a decreasing function of the time the client plans to remain with its present bank and the cost of switching to a new bank. Since the bank's learning is cumulative, the longer a client remains with its bank the smaller is the commitment price adjustment resulting from an aberrant takedown. The enhanced commitment price certainty, obtained with longevity of the client relationship, helps to explain client reluctance to switch banks. Since the optimal takedown is an increasing function of client riskiness under adaptive pricing, such pricing may serve the added purpose of providing information on client risk.     

Efficient sets with and without the expected utility hypothesis

Consider a feasible set, X, of c.d.f.'s. Assume that the set of decision makers, who must choose from X, includes non-expected utility decision makers who are risk averse in some weaker notions. We show that in this case the efficient set of X expands relative to the expected utility case. We characterize the efficient sets for each notion of risk aversion including the expected utility case. It is also shown that the limited-coverage insurance policies, which are not efficient under the expected utility hypothesis, belong to the efficient set when weakly risk-averse non- expected utility functionals are assumed to exist.     

Optimal strike prices of stock options for effort-averse executives

This paper evaluates the common practice of setting the strike prices of executive option plans at-the-money. Hall and Murphy [Hall, Brian, Murphy, Kevin J., 2000. Optimal exercise prices for executive stock options. American Economic Review 90 (2), 209–214] claim this practice to be optimal since it maximizes the sensitivity of compensation to firm performance. However, they do not incorporate effort and the possibility that managers are effort-averse into their model. We revisit this question while explicitly introducing these factors and allowing the reward package to include fixed wages, options, and stock grants. We simulate the manager’s effort choice and compensation as well as the value of shareholders’ equity under alternative compensation schemes, and identify schemes that are optimal. Our simulations indicate that, when abstracting from tax considerations, it is optimal to award managers with options that will most likely be highly valuable (i.e., substantially in-the-money) on their expiration date. Prior to 2006, the tax code and financial reporting standards provided incentives to award options that are closer to the money when issued than the options that were optimal in the absence of these considerations. Recent tax and reporting changes voided these incentives and thus we predict that these changes will induce firms to issue options with lower strike prices than those that were issued prior to 2006.