Fundamentals, information, and international capital flows: A welfare analysis

In the recent discussion surrounding the design of a new international financial architecture, enhancing transparency has widely been proposed as a policy essential for increasing the efficiency of international capital markets. This paper uses a simple two-country (two-agent) general equilibrium model with incomplete markets and production to explore the welfare consequences of an increase in public information about country-specific fundamentals (increase in transparency). An improvement in the quality of information has two effects on the ex ante welfare of individual countries: A direct effect that increases the efficiency of global capital allocation and welfare, and an indirect general equilibrium effect that increases asset price volatility and may decrease welfare. When the degree of risk-aversion is low, at least one country will gain from an increase in information quality. If the degree of risk-aversion is high, then there are robust examples of economies for which an increase in information hurts all countries. The paper also discusses how certain institutional arrangements (international derivative markets, international agency) could ensure that all countries gain from better information by providing insurance against information-induced asset price risk.     

Expectations,substitution, and scrapping in a putty-clay model

The paper presents a framework for analyzing the effect of changing expectations about future prices on a firm's choice of technique, and on its anticipated scrapping of capital equipment. Assuming a putty-clay technology, particular attention is paid to the way in which the scrapping age depends on the degree of ex ante input substitution. Numerical illustrations — based on data for Norwegian manufacturing for the years 1964–1983, an ex ante technology represented by a Generalized Leontief cost function in materials, energy, labor, and capital, and an ARMA representation of the price expectation mechanism — are presented. The results indicate that the price changes in this period may have had a substantial impact on planned scrapping, and on the chosen production techniques.     

Auction and the informed seller problem

A seller possessing private information about the quality of a good attempts to sell it through a second-price auction with announced reserve price. The choice of a reserve price transmits information to the buyers. We characterize the equilibria with monotone beliefs of the resulting signaling game and show that they lead to a reduced probability of selling the good compared to the symmetric information situation. We compare the unique separating equilibrium of this signaling game to the equilibrium of a screening game in which an uninformed monopoly broker chooses the trading mechanism. We show that the ex ante expected probability of trade may be larger with a monopoly broker, as well as the ex ante total expected surplus.     

Information-constrained optima with retrading: An externality and its market-based solution

This paper studies the efficiency of competitive equilibria in environments with a moral hazard problem and unobserved states, both with retrading in ex post spot markets. The interaction between private information problems and the possibility of retrade creates an externality, unless preferences have special, restrictive properties. The externality is internalized by allowing agents to contract ex ante on market fundamentals determining the spot price or interest rate, over and above contracting on actions and outputs. Then competitive equilibria are equivalent with the appropriate notion of constrained Pareto optimality. Examples show that it is possible to have multiple market fundamentals or price-islands, created endogenously in equilibrium.     

Modelling information and hedging: The exporting firm

The paper examines the economic role of modelling information on the decision problem of an exporting firm under exchange rate risk and hedging. Information is described in terms of market transparency, i.e., a publicly observable signal conveys more information about the random foreign exchange rate. We analyze the interaction between market transparency and the ex ante expected utility of the exporting firm. It is shown that more transparency on the foreign exchange market may result in higher or lower export production.     

Optimal selling strategies when buyers may have hard information

Consider a revenue-maximizing seller who can sell an object to one of n potential buyers. Each buyer either has hard information about his valuation (i.e., evidence that cannot be forged) or is ignorant. The optimal mechanism is characterized. It turns out that more ignorance can increase the expected total surplus. Even when the buyers are ex ante symmetric, the object may be sold to a buyer who does not have the largest willingness-to-pay. Nevertheless, an additional buyer increases the expected total surplus in the symmetric case, whereas more competition can be harmful if there are ex ante asymmetries.     

The value of information in a principal-agent model with moral hazard: The ex post contracting case

In a principal-agent model with moral hazard, a signal about the principal?s technology — the stochastic mapping from the agent?s action to the outcome — is observed before the contract is offered. The signal is either uninformative (null information), informative and observed only by the principal (private information), or also observed by the agent (public information). We show that, from an ex ante standpoint (before the signal is observed): (i) the agent prefers private to both null and public information; (ii) the principal sometimes prefers null to both private and public information; and (iii) when the principal prefers public to null information, she prefers public to private information, whereas the agent prefers private to public information. In this last situation, we also show that (iv) for any separating equilibrium with private information, there exists a contract with public information that both strictly prefer.     

Timing of decisions and the competitive firm under input price uncertainty

This paper studies the behavior of a competitive firm faced with input price uncertainty when the ex ante decision variable is output, not the quantities of the inputs. Highly unconventional results are obtained about the effects of uncertainty and of marginal increases in risk.     

Optimal auctions with information acquisition

This paper studies optimal auction design in a private value setting with endogenous information gathering. We develop a general framework for modeling information acquisition when a seller wants to sell an object to one of several potential buyers, who can each gather information about their valuations prior to participation in the auction. We first demonstrate that the optimal monopoly price is always lower than the standard monopoly price. We then show that standard auctions with a reserve price remain optimal among symmetric mechanisms, but the optimal reserve price lies between the ex ante mean valuation of bidders and the standard reserve price in Myerson (1981). Finally, we show that the optimal asymmetric mechanism softens the price discrimination against “strong” bidders.     

Competition and confidentiality: Signaling quality in a duopoly when there is universal private information

We model non-cooperative signaling by two firms that compete over a continuum of consumers, assuming each consumer has private information about the intensity of her preferences for the firms' respective products and each firm has private information about its own product's quality. We characterize a symmetric separating equilibrium in which each firm's price reveals its respective product quality. We show that the equilibrium prices, the difference between those prices, the associated outputs, and profits are all increasing functions of the ex ante probability of high safety. If horizontal product differentiation is sufficiently great then equilibrium prices and profits are higher under incomplete information about quality than if quality were commonly known. Thus, while signaling imposes a distortionary loss on a monopolist using price to signal quality, duopolists may benefit from the distortion as it can reduce competition. Finally, average quality is lower since signaling quality redistributes demand towards low-quality firms.     

Output and price level effects of monetary uncertainty in a matching model

Monetary uncertainty and information lags are put into a random matching model so that the resulting setting has some meetings in which producers are relatively informed and others in which consumers are relatively informed.For that setting, the ex ante socially optimal way to conduct trade is characterized. The optimum can display a variety of relationships between money and total output and the price level. While the price level is always sticky, even the direction of its response and that of total output depend on the magnitude of the lag and on subtle features of the serial correlation properties of the money supply.     

Alternative theories of wage dispersion

We analyze labor market models where the law of one price fails—i.e., models with equilibrium wage dispersion. We begin considering ex ante heterogeneous workers, but highlight a problem with this approach: If search is costly the market shuts down. We then assume homogeneous workers but ex post heterogeneous matches. This model is robust to search costs, and delivers equilibrium wage dispersion. However, we prove that the law of two prices holds: Equilibrium implies at most two wages. We explore other models, including one combining ex ante and ex post heterogeneity which is robust and delivers more realistic wage dispersion.     

Unequal uncertainties and uncertain inequalities: an axiomatic approach

In this paper, we provide an axiomatic characterization of social welfare functions for uncertain incomes. Our most general result is that a small number of reasonable assumptions regarding welfare orderings under uncertainty rule out pure ex ante as well as pure ex post evaluations. Any social welfare function that satisfies these axioms should lie strictly between the ex ante and the ex post evaluations of income distributions. We also provide an axiomatic characterization of the weighted average of the minimum and the maximum of ex post and ex ante evaluations.     

Partial vertical ownership

A backward ownership interest held by a downstream firm yields a partial rebate of the upstream margin. Input demand increases with backward ownership, and the upstream firm optimally responds by raising price. With symmetric costs, every downstream firm's equilibrium input/output choice is invariant across a class of ownership profiles, including uniform ownership. Moreover, equity trading results in uniform holdings, so partial vertical ownership may have no real effects. With asymmetric costs ex ante, equity trading amplifies the asymmetries and shifts output toward lower-cost firms. With homogeneous goods, this improves producer and total surplus. With differentiated goods, it may harm consumers.     

On the efficiency of ex ante and ex post pricing institutions

Summary This paper compares the performance of three pricing institutions in a decentralized matching model in which random matching occurs. In the first, sellers make public ex ante commitments to trade at pre-specified prices before matching occurs. In the second, the buyer and seller engage in an alternating offer bargaining game once a match has occurred. In the final pricing institution, one party is chosen at random to make a take it or leave it price offer. The steady state equilibrium with ex ante pricing pareto dominates the steady state equilibrium with ex post take it or leave it offers, which in turn pareto dominates the steady state equilibrium with alternating offers. As the discount factor goes to one, the equilibrium with ex ante pricing generates participation rates that tend toward the pareto efficient level. The ex post pricing institutions generate participation rates that are bounded away from efficient levels. The surplus loss associated with switching from ex ante pricing to take it or leave it offers is small when the discount factor is close to one. Contrary to many models of decentralized trade, ex post pricing institutions encourage too much search by buyers.The financial support of the Social Sciences and Humanities Research Council of Canada is gratefully acknowledged. The research for this paper was completed while the author was visiting the University of California at San Diego. The author thanks Douglas Gale for comments.     

Oligopolistic Competition and New Technology Adoption under Uncertainty

The paper examines the adoption of a new technology in oligopoly, where there is ex ante uncertainty about variable costs of the new technology. Each firm can either adopt the new process by bearing some up-front investment or may continue to use the old one, after which firms play a Cournot market game. If in equilibrium both technologies are employed, more uncertainty about the new technology increases (decreases) the number of innovating firms and decreases (increases) the product price if the up-front investment is large (small). Our model applies readily to vertical integration if integrated firms neither buy nor sell the intermediate good on the market. However, if buying and selling is allowed, the number of integrated firms is independent of input price uncertainty.     

Bargaining In International Trade Under Exchange-Rate Uncertainty

This paper examines the implications of various contracting alternatives between exporting and importing firms on the volume of international transactions. the contracts that we study are determined in a bargaining situation under exchange-rate uncertainty. First we look at contracts which entail an ex ante commitment on price and quantity of exports without the possibility of renegotiation ex post. Second, spot contracts, i.e., the price and the quantity of exports are negotiated after the exchange the rate is known. A third type of contracts consists of ex ante commitment and ex post renegotiation.     

RETAIL PRICE REGULATION AND THE OPTION TO DELAY

ABSTRACT ** :  This paper examines a two-period model of an investment decision in a network industry characterized by demand uncertainty, economies of scale and sunk costs. In the absence of regulation we identify the market conditions under which a monopolist decides to invest early as well as the underlying overall welfare output. In a regulated environment, we consider a monopolist who faces no downstream (final good) competition but is subject to retail price regulation. We identify the welfare-maximizing regulated prices when the unregulated market outcome is set as the benchmark. We show that if the regulator can commit to ex post regulation – that is, regulated prices that are contingent to future demand realization – then regulated prices that allow the firm to recover its total costs of production are welfare-maximizing. Thus, under ex post price regulation there is no need to compensate the regulated firm for the option to delay that it foregoes when investing today. We argue, however, that regulators cannot make this type of commitment and, therefore, price regulation is often ex ante – that is, regulated prices are not contingent to future demand. We show that the optimal ex ante regulation, and the extent to which regulated prices need to incorporate an option to delay, depend on the nature of demand uncertainty.     

Using Stock Price Information to Regulate Firms

This paper examines the role of the information contained in stock prices in the regulation of privatized firms. Stock prices contain noisy but unbiased information about firm's future prospects that regulators can use to decide on some regulatory policies. The main argument developed is that the observation of stock price movements reduces the incentives of regulators to develop their own monitoring technologies and can allow them to commit to relatively light-handed regulations. This protects firm's investments in cost reduction activities and can increase ex ante welfare.     

Input Prices as Signals of Costs to a Downstream Rival and Customer

We consider a dual distribution channel in which a vertically integrated manufacturer competes with a downstream rival in a retail market and also sells an input to the rival. We use a signalling model with a continuum of types to examine a situation in which the manufacturer has private information on the production cost of its retail product. We show that in a separating equilibrium under Cournot (Bertrand) retail competition, the manufacturer signals the uncompetitiveness (competitiveness) of its firm by charging a smaller input price than the optimal price under complete information.