Designing international environmental agreements under participation uncertainty

Traditional international environmental agreement (IEA) models usually use some specific contribution rules, which either fail to provide sufficient incentives for cooperation, or ignore the loss from participation uncertainty. Can more general rules overcome these problems and improve the performance of IEAs? This paper analyzes the endogenous determination of contribution rules from a class of general rules through a three-stage coalition formation game under participation uncertainty. In stage one, a designer chooses a contribution rule, which, depending on the size of the signatories’ coalition formed in stage two, specifies the action each signatory should take in stage three. A contribution rule is said to be optimal when it maximizes the expected payoff of signatories. We provide an algorithm to determine an optimal rule. When uncertainty is either sufficiently large or equal to zero, the optimal rule coincides with some existing rules in the literature. However, when the uncertainty is neither large nor small, the optimal rule outperforms other rules in terms of signatories’ payoff.     

Experimentation with heteroskedastic noise

Conclusion The direction of information with respect to the choice variable can easily change under a general class of distributions. The implication is that, when information is a function of the choice variable, the result of a model may be an outcome of the structure of the uncertainty and not of the existence of uncertainty. Thus, incomplete information does not always have such a clear effect on an agent's decision as previous models have suggested. If such results are key to the conclusions, then the structure of the model should be examined.The model presented here can be used to determine the relationship between information and the choice variable and to derive basic insights into the particular model being examined. It can also be used to eliminate the informational aspect of decisions so as to examine other aspects of a model, e.g., the incentive for information transmission (jamming) and other dynamic aspects (e.g., capital accumulation). Finally, the functional form of the unknown function as well as the error function are inportant in determining the direction of increased information, as the direction of increased noise can be the direction of experimentation.In models ofactive learning orexperimentation with noisy observations, the informativeness of the signal obviously depends on the (not always evident) relationship between the choice variable and the noise. This previously implicit relationship is made explicit by introducing heteroskedastic noise into the model. The general conditions for the informativeness of the signal to beindependent ordecrease with respect to the choice variable are obtained. Furthermore, the model reveals that many of the results in previous models of learning do not arise from what is unknown nor the existence of uncertaintyper se, but rather from how incomplete information is modeled.JEL D42, D83.     

Differences and similarities between ecological and economic models for biodiversity conservation

In this paper we investigate an important obstacle which substantially complicates co-operation between ecologists and economists but which has received little attention so far: differences between the modelling approaches in economics and ecology. To understand these differences, 60 models addressing issues relevant to biodiversity conservation have been selected randomly from eight international economic and ecological journals. The models have been compared according to a number of criteria including the models' level of generality; the mathematical techniques employed for formulation and solution of the models; the level of complexity and the way time, space and uncertainty are taken into account. The economic models sampled are formulated and analysed analytically, tend to be relatively simple and are mostly used to investigate general questions. Furthermore, they often ignore space, dynamics and uncertainty. Although some ecological models have similar properties, there is also a substantial number of another type of ecological models that are relatively complex and analysed by simulation. These models tend to be rather specific and often explicitly consider dynamics, space and uncertainty. The integrated ecological-economic models are observed to lie “in the middle” between ecological and economic models. An unexpected result is that they are not more complex than ecological and economic models (as one could have expected from a simple “merger” of models from both disciplines), but have an intermediate complexity.     

Finite Sample Limited Information Inference Methods for Structural Equations and Models With Generated Regressors

We propose exact tests and confidence sets for various structural models typically estimated by IV methods, such as models with unobserved regressors, which remain valid despite the presence of identification problems or weak instruments. Two approaches are considered: (1) an instrument substitution method, which generalizes the Anderson–Rubin procedure, and (2) a sample‐split method, that allows the use of “generated regressors.” Projection techniques are also proposed for inference on general parameter transformations. The asymptotic theory of the tests under weaker assumptions is discussed. Simulation results are presented. The suggested techniques are applied to a model of Tobin's q and to a model of academic performance.     

Computing equilibria with increasing returns

This paper shows how standard algorithms for solving economic general equilibrium models may be modified so as to solve models in which some or all industries have increasing returns to scale. The modification requires that some quantities as well as prices be quoted by the algorithmic auctioneer. It is applicable to a wide range of models in which firms pricing behavior follows simple rules. As an illustration of the technique a small general equilibrium model with increasing returns is presented and solved numerically.     

On capital accumulation paths in a neoclassical stochastic growth model

Summary. Boldrin and Montrucchio [2] showed that any twice continuously differentiable function could be obtained as the optimal policy function for some value of the discount parameter in a deterministic neoclassical growth model. I extend their result to the stochastic growth model with non-degenerate shocks to preferences or technology. This indicates that one can obtain complex dynamics endogenously in a wide variety of economic models, both under certainty and uncertainty. Further, this result motivates the analysis of convergence of adaptive learning mechanisms to rational expectations in economic models with (potentially) complicated dynamics. Received: June 21, 1996; revised version: October 31, 1996     

Tolerance for uncertainty and the growth of informationally opaque industries

Hofstede's [Hofstede, Geert H. 1980. Culture's consequences: international differences in work-related values. Thousand Oaks, CA: Sage.] cross-country psychological survey of IBM employees finds that some countries (societies) are systematically less tolerant of uncertainty, while uncertainty-tolerance is shown by some theoretic models to be essential to the growth of emerging sectors about which less is known. This paper first uses Durnev, Morck, and Yeung's [Durnev, Art, Morck, Randall, and Yeung, Bernard. 2004. Value-enhancing capital budgeting and firm-specific stock return variation. The Journal of Finance. 59(1): 65–105.] methodology to identify these informationally opaque industries. The hypothesis is then made that countries characterized by high uncertainty aversion (measured by Hofstede's indicator, and two other alternative indicators) will grow disproportionately slower in industrial sectors where information is less available. Using the Rajan and Zingales [Rajan, Raghuram G. and Zingales, Luigi. 1998. Financial Dependence and Growth. American Economic Review. Vol. 88(3): 559–586.] “difference-in-differences” methodology, which is relatively free from the endogeneity problem, the study provides robust evidence of such an industrial growth pattern in 34 countries and 36 manufacturing industries. It also shows that national uncertainty aversion is not driven by underdevelopment of financial sector, inadaptability of civil law systems, lower level of economic or human capital development, labor market inflexibility, or any of many other institutional factors. The results remain robust when religious (Catholic vs. Protestant) composition is used as an instrumental variable for national uncertainty aversion. The international evidence presented helps explain why some countries are slower in embracing “new” (vs. traditional) industries.     

Evaluating the effect of monetary policy on unemployment with alternative inflation forecasts

This paper explores the role that inflation forecasts play in the uncertainty surrounding the estimated effects of alternative monetary rules on unemployment dynamics in the euro area and the US. We use the inflation forecasts of 8 competing models in a standard Bayesian VAR to analyse the size and the timing of these effects, as well as to quantify the uncertainty relative to the different inflation models under two rules. The results suggest that model uncertainty can be a serious issue and strengthen the case for a policy strategy that takes into account several sources of information. We find that combining inflation forecasts from many models not only yields more accurate forecasts than those of any specific model, but also reduces the uncertainty associated with the real effects of policy decisions. These results are in line with the model-combination approach that central banks already follow when conceiving their strategy.     

Tolerance for uncertainty and the growth of informationally opaque industries

Hofstede's [Hofstede, Geert H. 1980. Culture's consequences: international differences in work-related values. Thousand Oaks, CA: Sage.] cross-country psychological survey of IBM employees finds that some countries (societies) are systematically less tolerant of uncertainty, while uncertainty-tolerance is shown by some theoretic models to be essential to the growth of emerging sectors about which less is known. This paper first uses Durnev, Morck, and Yeung's [Durnev, Art, Morck, Randall, and Yeung, Bernard. 2004. Value-enhancing capital budgeting and firm-specific stock return variation. The Journal of Finance. 59(1): 65–105.] methodology to identify these informationally opaque industries. The hypothesis is then made that countries characterized by high uncertainty aversion (measured by Hofstede's indicator, and two other alternative indicators) will grow disproportionately slower in industrial sectors where information is less available. Using the Rajan and Zingales [Rajan, Raghuram G. and Zingales, Luigi. 1998. Financial Dependence and Growth. American Economic Review. Vol. 88(3): 559–586.] “difference-in-differences” methodology, which is relatively free from the endogeneity problem, the study provides robust evidence of such an industrial growth pattern in 34 countries and 36 manufacturing industries. It also shows that national uncertainty aversion is not driven by underdevelopment of financial sector, inadaptability of civil law systems, lower level of economic or human capital development, labor market inflexibility, or any of many other institutional factors. The results remain robust when religious (Catholic vs. Protestant) composition is used as an instrumental variable for national uncertainty aversion. The international evidence presented helps explain why some countries are slower in embracing “new” (vs. traditional) industries.     

On the stability of the constant relative risk aversion (CRRA) utility under high degrees of uncertainty

Growth models under uncertainty and constant relative risk aversion (CRRA) utility are fragile in explaining consumers’ choice, as equilibrium consumption is dependent on distributional assumptions. We show that, under semi-nonparametric distributions, general equilibrium models are stable, as the existence of expected utility is guaranteed.     

A martingale characterization of the price of a nonrenewable resource with decisions involving uncertainty

This paper presents a general model of nonrenewable resource consumption and exploration decisions involving uncertainty about the time of occurrence of an event such as exhaustion, stock discovery, or a substitute development. The resulting price process is characterized in terms of necessary and sufficient conditions under which the price is expected to rise at a rate equal to, greater than, or less than the discount rate. The general model is illustrated and the price process and the optimal decisions are characterized by examining the three types of uncertainty indicated above.     

Equilibrium with arbitrary market structure

Summary. Fifty years ago Arrow [1] introduced contingent commodities and Debreu [4] observed that this reinterpretation of a commodity was enough to apply the existing general equilibrium theory to uncertainty and time. This interpretation of general equilibrium theory is the Arrow-Debreu model. The complete market predicted by this theory is clearly unrealistic, and Radner [10] formulated and proved existence of equilibrium in a multiperiod model with incomplete markets.In this paper the Radner result is extended. Radner assumed a specific structure of markets, independence of preferences, indifference of preferences, and total and transitive preferences. All of these assumptions are dropped here. We - like Radner - keep assumptions implying compactness.Received: 17 April 2003, Revised: 26 March 2004, JEL Classification Numbers: D52, D40.     

Doubts or variability?

Reinterpreting most of the market price of risk as a price of model uncertainty eradicates a link between asset prices and measures of the welfare costs of aggregate fluctuations that was proposed by Hansen, Sargent, and Tallarini [17], Tallarini [30], Alvarez and Jermann [1]. Prices of model uncertainty contain information about the benefits of removing model uncertainty, not the consumption fluctuations that Lucas [22] and [23] studied. A max-min expected utility theory lets us reinterpret Tallarini's risk-aversion parameter as measuring a representative consumer's doubts about the model specification. We use model detection instead of risk-aversion experiments to calibrate that parameter. Plausible values of detection error probabilities give prices of model uncertainty that approach the Hansen and Jagannathan [11] bounds. Fixed detection error probabilities give rise to virtually identical asset prices as well as virtually identical costs of model uncertainty for Tallarini's two models of consumption growth.     

Impacts of back to the land policies

A model of rural-urban migration is formulated for some developing economies. The emphasis is on decision making under uncertainty by the rural household. An income effect which is related to some hypotheses concerning behavior of the household towards risk is included along with a conventional price effect in the model. The impact of back to the land policies on the rate of migration in this model differs from the results of some models by Todaro and Harris and several refinements to the Harris-Todaro model as are nicely summed up in an article entitled ‘Internal Migration and Economic Development: An Overview’ by Lucas. The principal result of this analysis lies in its challenge to the conventional wisdom that back to the land policies necessarily dampen rural exodus.     

Improving Mineral Taxation Policy in Australia*

Australian State governments have begun to increase royalty rates and other mineral taxes. The most instructive approach to taxation policy for the minerals sector is to set up a general model of mines which year the optimal structure of taxes. A model of mine production under uncertainty is presented. The optimal tax is a single tax with two parts. a bonus bid and conditional tax payments based on the ex-post rent of the mine. The actual structure of taxes levied by State and Commonwealth governments is seen to be distinctly sub-optimal in several respects. Proposals to move the actual to word the optimal structure are made, recognizing some of the constraints on information and the maximum acceptable rate of tax reform .     

Robustness and information processing

This paper considers a standard Kalman filtering problem subject to model uncertainty and information-processing constraints. It draws a connection between robust filtering [Hansen and Sargent, 2004. Robust control and economic model uncertainty. Monograph. In press] and Rational Inattention [Sims, 2003. Implications of rational inattention, Journal of Monetary Economics 50 (3), 665–690]. Considered separately, robustness and Rational Inattention are shown to be observationally equivalent, in the sense that a higher filter gain can either be interpreted as an increased preference for robustness, or an increased ability to process information. However, it is more interesting to consider them jointly. In this case, it is argued that an increased preference for robustness can be interpreted as an increased demand for information processing, while Sims' model of Rational Inattention can be interpreted as placing a constraint on the available supply. This suggests that the way agents actually implement robust decision rules is by allocating some of their scarce information processing capacity to problems that are characterized by high degrees of model uncertainty and risk-sensitivity.     

Individual preferences and the effect of uncertainty on irreversible investment

This paper considers a relationship between investment behavior and an agent’s preferences in a stochastic one-sector growth model with irreversible investment. Further, it explores the effect of uncertainty in investment policies by using a non-expected utility function. Since uncertainty has an impact on investment policies not only through an option value but also through a risk-adjusted time preference rate in a general equilibrium framework, it is significant to distinguish the two preference parameters of the agent. While the previous partial equilibrium models with irreversible investment have exhibited a negative relationship between the desired capital stock and uncertainty, this paper implies that it is possible to generate a positive relationship for the appropriate parameters. This shows that the results of Hartman and Abel have been robust even in a general equilibrium model.     

Speculative attacks and defenses as wars of attrition

This paper extends the currency crisis models in Obstfeld [Obstfeld, M., 1994. The logic of currency crises. Cahiers Economiques et Monetaries], [Obstfeld, M., 1996. Models of currency crises with self-fulfilling features. European Economic Review 40, 1037–1047] by modeling both the government's side and speculators' side and introducing uncertainty about each party's payoff. We argue that a speculative attack (defense) can be well modeled as a war of attrition between the government and speculators under asymmetric information. We then solve for a pure strategy, weakly perfect, Bayesian rational expectation equilibrium in which each party's time until concession depends on her benefits from winning and her costs of fighting. Using this model, we are able to explain important facts of currency crises. First, the model shows that failed defenses (attacks) can be ex-ante rational for governments (speculators). Second, the model predicts systematic variations in the durations of defenses. Finally, we also show that currency crises can be self-fulfilling in the sense that there exist multiple rational expectation equilibria in our model.     

Knightian uncertainty and moral hazard

This paper presents a principal-agent model in which the agent has imprecise beliefs. We model this situation formally by assuming the agent?s preferences are incomplete as in Bewley (1986) [2]. In this setting, incentives must be robust to Knightian uncertainty. We study the implications of robustness for the form of the resulting optimal contracts. We give conditions under which there is a unique optimal contract, and show that it must have a simple flat payment plus bonus structure. That is, output levels are divided into two sets, and the optimal contract pays the same wage for all output levels in each set. We derive this result for the case in which the agent?s utility function is linear and then show it also holds if this utility function has some limited curvature.     

On a general equilibrium model of the incidence of the corporation tax under uncertainty

This paper addresses two issues. First, we demonstrate that when there is uncertainty in a general equilibrium model of a large country the usual rule for the auctioneer, that of searching for a set of relative prices at which excess demand in each market is zero, is no longer appropriate. It is suggested that the setting of expected demand to expected supply in each market would be a convenient generalization. Secondly, results on the incidence of the corporation income tax when there is uncertainty in the corporate sector, and alternatively when there is uncertainty in the noncorporate sector, are presented.