Informed traders and limit order markets

We consider a dynamic limit order market in which traders optimally choose whether to acquire information about the asset and the type of order to submit. We numerically solve for the equilibrium and demonstrate that the market is a “volatility multiplier”: prices are more volatile than the fundamental value of the asset. This effect increases when the fundamental value has high volatility and with asymmetric information across traders. Changes in the microstructure noise are negatively correlated with changes in the estimated fundamental value, implying that asset betas estimated from high-frequency data will be incorrect.     

Competition and product innovation in dynamic oligopoly

We investigate the relationship between competition and innovation using a dynamic oligopoly model that endogenizes both the long-run innovation rate and market structure. We use the model to examine how various determinants of competition, such as product substitutability, entry costs, and innovation spillovers, affect firms’ equilibrium strategies for entry, exit, and investment in product quality. We find an inverted-U relationship between product substitutability and innovation: the returns to innovation initially rise for all firms but eventually, as the market approaches a winner-take-all environment, laggards have few residual profits to fight over and give up pursuit of the leader, knowing he will defend his lead. The increasing portion of the inverted-U reflects changes in firm’s investment policy functions, whereas the decreasing portion arises from the industry transiting to states with fewer firms and wider quality gaps. Allowing market structure to be endogenous yields different results compared to extant work that fixes or exogenously varies the market structure.     

Structural Applications of the Discrete Choice Model

A growing body of empirical literature uses structurally-derived economic models to study the nature of competition and to measure explicitly the economic impact of strategic policies. While several approaches have been proposed, the discrete choice demand system has experienced wide usage. The heterogeneous, or mixed, logit in particular has been widely applied due to its parsimonious structure and its ability to capture flexibly substitution patterns for a large number of differentiated products.We outline the derivation of the heterogeneous logit demand system. We then present a number of applications of such models to various data sources. Finally, we conclude with a discussion of directions for future research in this area.     

Cofinancing to Manage Risk in the Motion Picture Industry

Cofinancing is a term used in the movie industry to describe films for which multiple firms share the cost of production and revenues. We find that one-third of movies produced by major studios between 1987 and 2000 are cofinanced. Anecdotal evidence strongly indicates that cofinancing is for the purpose of risk management. However, the major studios are publicly traded firms, which allows investors to make their own diversification decisions, leading us to question the importance of cofinancing for risk management. Contrary to industry claims, we find that cofinancing decisions are unrelated to the distribution of individual movie returns—studios do not appear to cofinance relatively risky films. But we do find that studios are more likely to cofinance movies that account for a large fraction of their total annual production budget, which reduces portfolio risk via the law of large numbers. Toward an alternative explanation for cofinancing, we also find that cofinancing between two major studios impacts the release dates of their other movies.