Theoretical tests of the rational expectations hypothesis in economic dynamical models

This paper examines different theoretical stability tests of infinite-horizon rational expectations equilibria. These ‘tests’ have different status: two of them express that the considered equilibrium is ‘isolated’ [neither (non-sunspot) equilibria (test 1) nor (well-behaved) sunspot equilibria exist in a neighbourhood (test 2)] and two of them are learning criteria [either standard ‘evolutive learning’ (test 3) or game-theoretical ‘eductive’ learning (test 4)]. Surprisingly, these four tests select the same steady state equilibria in the class of one-dimensional one-step-forward looking economic models. The extension of this equivalence theorem to n-dimensional and then more complex systems is discussed.     

Chaos and sector-specific externalities

Benhabib and Farmer [1996. Indeterminacy and sector specific externalities. Journal of Monetary Economics 37, 397–419] explore the possibility of local indeterminacy in a two-sector model with sector-specific externalities. They find that very small sector-specific externalities are sufficient for local indeterminacy. In this case, it is possible to construct sunspot equilibria where extrinsic uncertainty matters. In this paper, I provide a global analysis of their model revealing the existence of Euler equation branching. This branching allows for regime switching equilibria with cycles and chaotic behavior. These equilibria occur whether the “local dynamics” are determinate or indeterminate.     

Endogenous participation risk in speculative markets

This paper analyses the dynamic implications of an asset-pricing model with incomplete participation due to entry costs. It is shown that heterogeneity in entry costs can lead to the existence of multiple stochastic sunspot equilibria, whereby the number of agents in the market and asset prices fluctuate endogeneously over time in the absence of fundamental uncertainty. Such asset-price fluctuations occur despite the uniqueness of the deterministic equilibrium, and thus bear no link to the usual notion of steady-state indeterminacy. In addition to excess volatility, the equilibria exhibit predictable and conditionally heteroskedastic returns.     

International transmission of bubble crashes in a two-country overlapping generations model

We study the international transmission of bubble crashes by analyzing stationary sunspot equilibria in a two-country overlapping generations exchange economy with stochastic bubbles. We consider two cases of sunspot shocks. In the first case, we assume that only the foreign country receives a sunspot shock, while in the second, we assume that both countries independently receive sunspot shocks. In the first case, a bubble crash in the foreign country is always accompanied by a bubble crash in the home country. In the second case, a bubble crash in the foreign country can have a positive or negative effect on the home bubble. We also show that there exists a unique locally isolated stationary sunspot equilibrium, and that it is locally unstable.     

On the plausibility of sunspot equilibria

This study examines the plausibility of the emergence of sunspot equilibria in an agent-based artificial stock market. Using the agent-based model, we make the sunspots explicit so that we can test, e.g., by means of the Granger causality test, whether purely extrinsic uncertainty can influence price dynamics. In addition, through agent-based simulation, the coordination process, which is mainly driven by genetic programming, becomes observable, which enables us to analyze what agents perceive and whether they believe in sunspots. By manipulating different control variables, three series of experiments are conducted. Generally speaking, the chances of observing “sunspot equilibria” in this agent-based artificial stock market are small. However, the sunspot believers can never be driven out of the market. Nevertheless, they are always outnumbered by fundamental believers, which is evidence that the market as collective behavior is rational. We also find that lengthening the time horizon will make it difficult for sunspot believers to survive.     

Competing Platforms

Why do competing platforms or networks exist? This paper focuses on instances where the value of a platform depends on the adoption decisions of a small number of firms, and analyzes the strategic competition among platforms to get this oligopolistic side on‐board. I study a bilateral contracting game among platforms and firms that allows for general externalities across both contracting and noncontracting partners, and examine when a market will sustain a single or multiple platforms. When firms can join only one platform, I provide conditions under which market‐tipping and/or market‐splitting equilibria may exist. In particular, even without coordination failure, congestion effects, or firm multihoming, multiple platforms can co‐exist in equilibrium despite being inefficient from the perspective of the contracting parties. Expanding the contracting space to include contingent contracts may exacerbate this inefficiency.     

Equilibrium with coordination

The obvious equilibrium concepts in the simplest institutions for transferring ownership of commodities—bilateral exchange—are neither Nash equilibria nor cooperative equilibria. To study such equilibria as special cases of equilibria of a social system it is necessary to introduce coordination. Two or more agents coordinate their actions, if, when they consider an alternative to a state, they take as given—for agents with whom they coordinate—the alternative state. If there is no coordination we obtain Nash equilibrium as a special case. If there is complete coordination we obtain optimality as a special case. The main result is an existence theorem for a social system with coordination. This theorem is then applied to prove existence of exchange equilibria in an economy with bilateral exchange.     

Revealing Incentives for Compatibility Provision in Vertically Differentiated Network Industries

We determine the incentives for compatibility provision of firms that produce network goods with different intrinsic qualities when firms do not have veto power over compatibility. When network effects are strong, there are multiple equilibria in pricing and consumer decisions. We show that in some equilibria, it is the high‐quality firm that invests in compatibility, whereas in others, the low‐quality firm triggers compatibility. The socially optimal compatibility degree is zero, except under very strong network effects, where one of the equilibria has all consumers buying the low‐quality good. In this case, a partial degree of compatibility is optimal.     

Functional sunspot equilibria

Consider a one step forward looking model where agents believe that the equilibrium values of the state variable are determined by a function whose domain is the current value of the state variable and whose range is the value for the subsequent period. An agent’s forecast for the subsequent period uses the belief, where the function that is chosen is allowed to depend on the current realization of an extrinsic random process, and is made with knowledge of the past values of the state variable but not the current value. The paper provides (and characterizes) the conditions for the existence of sunspot equilibria for the model described.     

Monetary Policy Indeterminacy and Identification Failures in the U.S.: Results from A Robust Test

We propose a novel identification‐robust test for the null hypothesis that an estimated New Keynesian model has a reduced form consistent with the unique stable solution against the alternative of sunspot‐driven multiple equilibria. Our strategy is designed to handle identification failures as well as the misspecification of the relevant propagation mechanisms. We invert a likelihood ratio test for the cross‐equation restrictions (CER) that the New Keynesian system places on its reduced‐form solution under determinacy. If the CER are not rejected, sunspot‐driven expectations can be ruled out from the model equilibrium and we accept the structural model. Otherwise, we move to a second‐step and invert an Anderson and Rubin‐type test for the orthogonality restrictions (OR) implied by the system of structural Euler equations. The hypothesis of indeterminacy and the structural model are accepted if the OR are not rejected. We investigate the finite‐sample performance of the suggested identification‐robust two‐step testing strategy by some Monte Carlo experiments and then apply it to a New Keynesian AD/AS model estimated with actual US data. In spite of some evidence of weak identification as for the ‘Great Moderation’ period, our results offer formal support to the hypothesis of a switch from indeterminacy to a scenario consistent with uniqueness occurring in the late 1970s. Our identification‐robust full‐information confidence set for the structural parameters computed on the ‘Great Moderation’ regime turns out to be more precise than the intervals previously reported in the literature through ‘limited‐information’ methods. Copyright © 2014 John Wiley & Sons, Ltd.     

Die Theorie globaler Spiele: Private Information als Mittel zur Vermeidung multipler Gleichgewichte

Investment decisions with network effects, refinancing illiquid firms, and speculative attacks are typical examples for coordination games with multiple equilibria. By introducing private information about payoff relevant parameters, the theory of global games embeds such coordination games in a stochastic environment, in which the game may have a unique equilibrium. This paper provides an introduction to the theory of global games and shows that it delivers a unique equilibrium if private information is sufficiently precise, while public information may lead to equilibria with self-fulfilling beliefs. This implies some criteria for optimal mechanisms of information dissemination. For example, a well-informed central bank can minimize the prior probability of currency crises by committing to provide information to private actors with small idiosyncratic errors.     

Multiple equilibria and structural transition of non-monocentric urban configurations

A model of non-monocentric urban land use is presented, which requires neither employment nor residential location to be specified a priori. It is shown that the model is capable of yielding multicentric pattern as well as monocentric and dispersed patterns, and that the model generally yields multiple equilibria under each fixed set of parameter values. It is also shown that the city may undergo a catastrophic structural transition when the parameters take critical values.     

Aggregation in economies with search frictions

We derive an aggregation result in economies with indivisible labor supply choices and frictional labor markets, obtaining a tractable model of gross worker flows in aggregate labor markets with search frictions. Our result explores the fact that economies with non-convex choice sets and idiosyncratic shocks allow for sunspot equilibria à la Kehoe et al. (2002). We use comparative steady state analysis to demonstrate the applicability of our aggregation result. Our framework reconciles the neoclassical growth model with search frictions with a mildly procyclical participation rate and matches the gross worker flows underpinning those dynamics.     

Inference in a synchronization game with social interactions

This paper studies inference in a continuous time game where an agent’s decision to quit an activity depends on the participation of other players. In equilibrium, similar actions can be explained not only by direct influences but also by correlated factors. Our model can be seen as a simultaneous duration model with multiple decision makers and interdependent durations. We study the problem of determining the existence and uniqueness of equilibrium stopping strategies in this setting. This paper provides results and conditions for the detection of these endogenous effects. First, we show that the presence of such effects is a necessary and sufficient condition for simultaneous exits. This allows us to set up a nonparametric test for the presence of such influences, which is robust to multiple equilibria. Second, we provide conditions under which parameters in the game are identified. Finally, we apply the model to data on desertion in the Union Army during the American Civil War, and find evidence of endogenous influences.     

On the possibility of efficient bilateral trade

I study a sequential process in which different pairs of traders bargain over the terms of trade of an indivisible good. I consider bothone-sided andtwo-sided offers based bargaining at the stage-game level. The sequential process is modelled as an infinite stage-game of incomplete information and the paper studies the efficiency properties of its equilibria. It is shown: With one-sided offers, all equilibria are long-run ex post efficient; with two-sided offers, examples of equilibria are constructed with widely varying efficiency properties. This paper is based on Chapter 1 of my Ph.D thesis.     

Changes in risk and strategic interaction

In this paper we study the comparative statics of Nth degree stochastic dominance shifts in a large class of non-cooperative games. We consider symmetric equilibria as well as asymmetric equilibria in which the risk changes are idiosyncratic and not necessarily of the same stochastic order. Furthermore, we establish conditions for risk changes to produce multiplier effects on equilibrium strategies. Finally, we evaluate the comparative statics of stochastic dominance shifts in supermodular games, which may feature multiple equilibria and non-convex strategy sets.     

Accreditation in regulated markets

We study firms that supply a vertically and horizontally differentiated service in a market with regulated prices. The incentives for seeking accreditation are more significant for sellers of below-average quality services relative to sellers of above-average quality services. For homogenous firms, profits are lower in equilibria where both firms seek accreditation relatively to equilibria where neither does. Private and social accreditation incentives typically differ. The welfare optimal reimbursement rate is independent of a firm's actual accreditation decision but dependent on the accreditation decision of the rival. Hence, policies that give extra financial support to firms that accredit are likely to promote inefficiency.     

Rationality-in-Relations

A BSTRACT . If in a game with multiple proper coordination equilibria there is a single one that is best for all participants, it is rational for each participant to choose the strategy that has the best equilibrium as one of its possible outcomes. This seems so obvious that any plausible theory of rationality should be expected to be applicable to such situations. However, this is not true for the "orthodox" theory of rational choice, as Robert Sugden has convincingly shown. In this paper, I shall argue that this failure is due to an implicit individualistic understanding of intentionality . John R. Searle's concept of collective intentionality (as put forth in his Construction of Social Reality ) and his more recent theory of Rationality in Action provides important conceptual tools pertaining to a more comprehensive theory of rationality. The account I shall develop differs from Searle's own, as for reasons to be found in his overall project, Searle's departure from the orthodox view of rationality gets stuck half-way.     

Pre-play communication in procurement auctions: Silence is not golden

I study the effect of cheap talk between bidders on the outcome of a first-price procurement auction in which participation is costly. Although no side payments or commitments are allowed, there exists a family of equilibria in which sellers use communication to collude on a subset of participants and/or reveal information about their cost. Cheap talk matters in the sense that it strictly enlarges the set of Nash equilibria (symmetric and asymmetric) and the set of public correlated equilibria of the game. I show that the buyer may benefit from cheap talk between sellers and that the surplus increases in the amount of information revealed in equilibrium under one fairly general condition. This is because when communication is cheap, sellers cannot directly collude on higher prices. Rather, communication leads to competition between fewer, but more aggressive bidders, which entails greater allocative efficiency and a decrease in the total wasteful entry cost.     

Nash-implementation of competitive equilibria via a bounded mechanism

We deal with the problem of providing incentives for the implementation of competitive outcomes in a pure-exchange economy with finitely many households. We construct a feasible price-quantity mechanism, which fully implements Walras equilibria via Nash equilibria in fairly general environments. Traders’ preferences need neither to be ordered nor continuous. In addition, the mechanism is such that no pure strategy is weakly dominated, hence is bounded (in the sense of Jackson 1992). In particular it makes no use of any integer game.