Returns-to-scale and the equity premium puzzle

A model of heterogenous firms facing idiosyncratic risk is proposed which generates an equity premium of 6 per cent and a risk-free rate of 1.5 per cent even if aggregate returns are risk-free. The premium in this model reflects diminishing returns-to-scale and the fact that equity shares are equal claims to firm output. In the bond market, the risk-free rate reflects trade in assets at marginal rates of return with a linear technology and thus the equity premium in excess returns reflects a comparison of average returns with marginal returns. In the model, credit constraints lower the equity premium and, absent such constraints, the equity premium would roughly double. Since the model may be interpreted as a model of entrepreneurship, this paper also presents estimates from a structural model of entrepreneurship using data from the Survey of Consumer Finances and also finds only a modest level of risk aversion is sufficient to replicate entrepreneurial returns.     

Volatility, growth, and welfare

This paper constructs an endogenous growth model driven by self-fulfilling expectation shocks to explain the stylized fact that the average growth rate of GDP is related negatively to volatility and positively to capacity utilization. The implied welfare gain from further stabilizing the U.S. economy is about a quarter of annual consumption, which is consistent in order of magnitude with estimates based on the empirical studies of Ramey and Ramey (1995) and Alvarez and Jermann (2004). Hence, policies designed to reduce fluctuations can generate large welfare gains because smaller fluctuations are associated with permanently higher rates of growth.     

A portfolio approach to endogenous growth: equilibrium and optimal policy

This paper develops a portfolio approach to modeling endogenous growth in continuous time that is especially suitable for addressing fiscal and financial issues in policy design. The analysis focuses on the equilibrium relationship between fiscal and financial policy, rates of return and wealth allocation. We analyze two models. The first is based on the Arrow-Romer model with increasing returns and an external effect of capital on labor productivity. The second draws on Barro's analysis of government spending and endogenous growth. In both models, we study the equilibrium allocation and discuss the optimal fiscal and financial policy.     

A note on the closed-form solution to the Lucas–Uzawa model with externality

Ruiz-Tamarit [2008. The closed-form solution for a family of four-dimension nonlinear MHDS. Journal of Economic Dynamics and Control 32, 1000–1014] provides a closed-form solution to the two-sector model of endogenous growth with externalities. He assumes that the coefficient of the relative risk aversion is equal to the physical capital share, but this assumption is empirically and theoretically implausible. This note uses the result of Boucekkine and Ruiz-Tamarit [2008. Special functions for the study of economic dynamics: the case of the Lucas–Uzawa model. Journal of Mathematical Economics 44, 33–54] and derives a closed-form solution without setting the parametric assumption. The solution path is expressed in terms of the Gauss hypergeometric functions.     

Feasibility and optimality of sustainable growth under materials balance

Pollution from consumption and production is an inevitable part of economic processes. We employ a materials balance approach and develop an endogenous growth theory, with recycling activity, to examine the evolution of the economic and environment systems. This paper provides feasibility and optimality conditions for sustainable economic growth with rising environmental quality. The fundamental condition of feasibility is that the flow of natural resources, which eventually returns to the environment as waste and pollution, has a negative growth rate in the long run.     

Biased Bayesian learning with an application to the risk-free rate puzzle

Based on the axiomatic framework of Choquet decision theory, we develop a closed-form model of Bayesian learning with ambiguous beliefs about the mean of a normal distribution. In contrast to rational models of Bayesian learning the resulting Choquet Bayesian estimator results in a long-run bias that reflects the agent's ambiguity attitudes. By calibrating the standard equilibrium conditions of the consumption based asset pricing model we illustrate that our approach contributes towards a resolution of the risk-free rate puzzle. For a plausible parameterization we obtain a risk-free rate in the range of 3.5–5%. This is 1–2.5% closer to the empirical risk-free rate than according calibrations of the rational expectations model.     

Evolution of preferences and cross-country differences in time devoted to market work

I model the hypothesis that preferences evolve and permanent differences in individual attitudes towards work emerge between two countries characterized initially by identical preferences as a result of a period in which only one of the two countries is subject to regulations constraining labor supply, or as a by-product of different tax rates on labor income. Hence, the elimination of these regulations may not allow the economy thus deregulated to converge to the same hours of market work per person of the other economy, and the long-run differential in market work between economies subject to different tax rates is amplified.     

Spatial agglomeration and endogenous growth

This paper constructs a dynamic general equilibrium model with spatial interactions in which a human capital externality is the centripetal force towards agglomeration. The resource cost of transportation is, on the other hand, the main centrifugal force, preventing a city from growing unboundedly. A central feature of our analysis is the dynamic interaction between (perpetual) economic growth and (bounded) city growth. We examine the socially optimal and the decentralized growth rates as well as city sizes. In the decentralized environment, individuals under-invest, whereas cities are under-populated. We show how public policies may enable a decentralized city to attain the socially optimal allocation.     

An objective function for simulation based inference on exchange rate data

The assessment of models of financial market behaviour requires evaluation tools. When complexity hinders a direct estimation approach, e.g., for agent based microsimulation models, simulation based estimators might provide an alternative. In order to apply such techniques, an objective function is required, which should be based on robust statistics of the time series under consideration. Based on the identification of robust statistics of foreign exchange rate time series in previous research, an objective function is derived. This function takes into account stylized facts about the unconditional distribution of exchange rate returns and properties of the conditional distribution, in particular, autoregressive conditional heteroscedasticity and long memory. A bootstrap procedure is used to obtain an estimate of the variance-covariance matrix of the different moments included in the objective function, which is used as a base for the weighting matrix. Finally, the properties of the objective function are analyzed for two different agent based models of the foreign exchange market, a simple GARCH-model and a stochastic volatility model using the DM/US-$ exchange rate as a benchmark. It is also discussed how the results might be used for inference purposes. Research has been supported by the DFG grant WI 20024/2-1/2. We are indebted to two anonymous referees of this journal, Leigh Tesfatsion, Patrick Burns and other participants of the CEF’06 conference in Limassol for helpful comments on preliminary versions of this paper.     

Equilibrium dynamics in a class of one-sector endogenous growth models with external habits: An application of special functions

This paper analyzes the equilibrium dynamics in a class of one-sector endogenous growth models with external habits. Using an explicit solution expressed in terms of the Gauss hypergeometric function, we show that the levels of consumption, habits and capital may exhibit non-monotonic transition dynamics, even though their ratios converge monotonically. A numerical simulation illustrates this result.     

Wants and past knowledge: Growth cycles with emerging industries

This paper develops a theory of endogenous growth cycles focusing on the interaction between consumers' desire to satisfy an indefinite range of wants and firms' incentive to utilize knowledge from past production experiences. We show that firms endogenously form a number of distinguishable industries as accumulated knowledge induces them to agglomerate in the technology space. Knowledge accumulation in existing industries reduces production costs, but, as the diminishing returns from learning sets in, some firms start to adopt previously unexplored technologies so that their new goods fit consumers' unsatisfied wants and attract large demand. Thus, sporadic emergence of new industries generates growth cycles, where both the timing and the new technology to be adopted are endogenously determined. New industries based on new technology reduce the rate of per capita GDP growth in the initial phase, but nonetheless are indispensable for sustained economic growth in the long run.