Corporate liquidity and risk management with time-inconsistent preferences

This paper extends the model of corporate liquidity and risk management with limited commitment by incorporating time-inconsistent preferences. With respect to the firm's liquidity w = W∕K, it predicts that in the presence of time-inconsistency, the entrepreneur optimally responds by lowering the maximal debt capacity, over-consuming, under-investing and reducing both the idiosyncratic and systematic volatility of w. When disentangling the entrepreneur's belief with regard to future selves' time-inconsistent behavior, as a result of sophistication effect, the sophisticated entrepreneur reduces the endogenous debt capacity, invests less, decreases consumption, engages less in financial hedging and allocates even smaller liquid assets in the market portfolio than naive entrepreneur.     

Definitions of ambiguous events and the smooth ambiguity model

We examine a variety of preference-based definitions of ambiguous events in the context of the smooth ambiguity model. We first consider the definition proposed in Klibanoff et?al. (Econometrica 73(6):1849?C1892, 2005) based on the classic Ellsberg two-urn paradox (Ellsberg Q J Econ 75:643?C669, 1961) and show that it satisfies several desirable properties. We then compare this definition with those of Nehring (Math Soc Sci 38(2):197?C213, 1999), Epstein and Zhang (Econometrica 69:265?C306, 2001), Zhang (Econ Theory 20:159?C181, 2002), and Ghirardato and Marinacci (J Econ Theory 102:251?C289, 2002). Within the smooth ambiguity model, we show that Ghirardato and Marinacci (J Econ Theory 102:251?C289, 2002) would identify the same set of ambiguous and unambiguous events as our definition while Epstein and Zhang (Econometrica 69:265?C306, 2001) and Zhang (Econ Theory 20:159?C181, 2002) would yield a different classification. Moreover, we discuss and formally identify two key sources of the differences compared to Epstein and Zhang (Econometrica 69:265?C306, 2001) and Zhang (Econ Theory 20:159?C181, 2002). The more interesting source is that these two definitions can confound non-constant ambiguity attitude and the ambiguity of an event.     

The price of deposit liquidity: banks versus microfinance institutions

Using data from Bangladesh, this article finds that the liquidity premium – the difference between the interest paid on illiquid and liquid savings accounts – is higher in commercial banks than in microfinance institutions. One possible interpretation lies in the higher prevalence of time-inconsistency among the poor. The observed difference in liquidity premia could be due to poor time-inconsistent agents willing to forgo interest on illiquid savings accounts in order to discipline their future selves.     

Why stare decisis?

All Courts rule ex-post, after most economic decisions are sunk. This can generate a time-inconsistency problem. From an ex-ante perspective, Courts will have the ex-post temptation to be excessively lenient. This observation is at the root of the rule of precedent, known as stare decisis.Stare decisis forces Courts to weigh the benefits of leniency towards the current parties against the beneficial effects that tougher decisions have on future ones.We study these dynamics and find that stare decisis guarantees that precedents evolve towards ex-ante efficient decisions, thus alleviating the Courts' time-inconsistency problem. However, the dynamics do not converge to full efficiency.     

Stable schedule matching under revealed preference

Baiou and Balinski (Math. Oper. Res., 27 (2002) 485) studied schedule matching where one determines the partnerships that form and how much time they spend together, under the assumption that each agent has a ranking on all potential partners. Here we study schedule matching under more general preferences that extend the substitutable preferences in Roth (Econometrica 52 (1984) 47) by an extension of the revealed preference approach in Alkan (Econom. Theory 19 (2002) 737). We give a generalization of the Gale-Shapley algorithm and show that some familiar properties of ordinary stable matchings continue to hold. Our main result is that, when preferences satisfy an additional property called size monotonicity, stable matchings are a lattice under the joint preferences of all agents on each side and have other interesting structural properties.     

Quasi-hyperbolic preferences and retirement: A comment

Diamond and Koszegi [Diamond, P. and Koszegi, B. (2003), “Quasi-Hyperbolic Preferences and Retirement,” Journal of Public Economics, 87: 1839–1972] have argued that quasi-hyperbolic discounting can cause dynamic inconsistency in planning when to retire as well as in consumption plans. This comment shows that in a simple model with such preferences, retirement plans are never time-inconsistent, as these same preferences keep savings too low for individuals to ever be able to afford unplanned early retirement. Although only a simple example is presented here to demonstrate the point, this insight suggests the application of ordiamond03's framework should be reconsidered. The model presented needs to be extended to find robust general conclusions.     

On two kinds of manipulation for school choice problems

Many school districts in the US. employ centralized clearing houses to assign students to public schools. An important potential threat against any school choice mechanism is the tendency of schools to circumvent the procedure via two kinds of strategic manipulation: manipulation via capacities and manipulation via pre-arranged matches. This paper studies the extent of the vulnerability of three prominent school choice mechanisms that have been adopted (or, considered for adoption) by some school districts in the US. We find that the highly debated Boston mechanism as well as the top trading cycles mechanism are immune to manipulation via capacities, unlike the student-optimal stable mechanism (SOSM). We show that SOSM is immune to manipulation via capacities if and only if the priority structure satisfies an acyclicity condition proposed by Ergin (Econometrica 70:2489?C2497, 2002). On the other hand, we show that essentially no mechanism is immune to manipulation via pre-arranged matches.     

Investment options and the business cycle

This paper extends [R. Mehra, E.C. Prescott, Recursive competitive equilibrium: The case of homogeneous households, Econometrica 48 (1980) 1365-1380] to a production economy with two capital goods. It is an RBC model in which each unit of investment requires a new idea, an ‘option.’ When options are scarce, new capital is harder to put in place and the value of old capital rises. Thus the stock market and Tobin's Q are negative indexes of intangibles. During a boom, Q rises gradually, as options are used up. Because investment represents an exercise of options, it has an intertemporal substitution tradeoff that is absent from the adjustment-cost model. Equilibrium may be efficient even without markets for knowledge; the stock market may suffice.     

Second-best efficiency of allocation rules: strategy-proofness and single-peaked preferences with multiple commodities

We study strategy-proof allocation rules in economies with perfectly divisible multiple commodities and single-peaked preferences. In this setup, it is known that the incompatibility among strategy-proofness, Pareto efficiency and non-dictatorship arises in contrast with the Sprumont (Econometrica 59:509–519, 1991) one commodity model. We first investigate the existence problem of strategy-proof and second-best efficient rules, where a strategy-proof rule is second-best efficient if it is not Pareto-dominated by any other strategy-proof rules. We show that there exists an egalitarian rational (consequently, non-dictatorial) strategy-proof rule satisfying second-best efficiency. Second, we give a new characterization of the generalized uniform rule with the second-best efficiency in two-agent case.     

Consistent strategy-proof assignment by hierarchical exchange

We characterize the family of efficient, consistent, and strategy-proof rules in house allocation problems. These rules follow an endowment inheritance and trade procedure as in Pápai’s hierarchical exchange rules (Pápai in Econometrica 68, 1403–1433, 2000) and closely resemble Ergin’s priority rules (Ergin in Econometrica 70, 2489–2497, 2002). We prove that if there are at least four objects, these are the only rules that are efficient in two-agent problems, $2$ -consistent, and strategy-proof. A corollary is that these three basic properties together imply the full requirements of efficiency, consistency, group strategy-proofness, and reallocation-proofness.     

The art of conversation: eliciting information from experts through multi-stage communication

We examine the strategic interaction between an informed expert and an uninformed decision maker, extending the analysis of Crawford and Sobel (Econometrica 50 (1982) 1431). We modify their model to allow for more extensive communication between the two parties and show that face-to-face communication between the expert and the uninformed decision maker followed by a written report from the expert leads to improved information transmission. In (almost) all cases, there exists an equilibrium in our modified model that ex ante Pareto dominates all of the equilibria identified by Crawford and Sobel. This remains true even if the expert's bias is so great that in their model no information would be disclosed.     

Individual sense of fairness: an experimental study

Many prior studies have identified that subjects in experiments demonstrate preferences for fair allocations. We present an experimental study designed to test whether a similar concern for fairness manifests itself when the decision maker is choosing among differing probabilistic allocation mechanisms that will all generate an ex post unfair allocation by assigning an indivisible prize to one individual. This investigation is inspired by Karni and Safra (Econometrica, 70, 263–284, 2002 ) in which a structure for preferences for fairness in such an environment was developed. Here we use this model to design experiments that allow us to test for the presence of concern for fairness in individual choice behavior and examine some factors that may affect the intensity of the concern for fairness.

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Futures market: contractual arrangement to restrain moral hazard in teams

Holmstrom (Bell J Econ 13:324?C340, 1982) argues that a principal is required to restrain moral hazard in a team: wasting output in certain states is required to enforce efficient effort, and the principal is a commitment device for the waste. Under competition in commodity and team-formation markets, I extend his model à la Prescott and Townsend (Econometrica 52(1):21?C45, 1984) to show that competitive contracts can exploit the futures market to transfer output across states instead of wasting it. Thus, the futures market takes the place of a principal as a commitment device. Exploiting the duality of linear programming, I characterize the market environment and the contractual agreements for incentive-constrained efficiency.     

Information structures with unawareness

I construct a state space model with unawareness following [R.J. Aumann, Agreeing to disagree, Ann. Stat. 76 (1976) 1236-1239]. Dekel et al. [E. Dekel, B.L. Lipman, A. Rustichini, Standard state-space models preclude unawareness, Econometrica 66 (1998) 159-173] show that standard state space models are incapable of representing unawareness. The model circumvents the impossibility result by endowing the agent with a subjective state space that differs from the full state space when he has the unawareness problem. Information is modeled as a pair, consisting of both factual information and awareness information. The model preserves the central properties of the standard information partition model.     

Ambiguous events and maxmin expected utility

We study the properties associated to various definitions of ambiguity [L.G. Epstein, J. Zhang, Subjective probabilities on subjectively unambiguous events, Econometrica 69 (2001) 265-306; P. Ghirardato et al., Differentiating ambiguity and ambiguity attitude, J. Econ. Theory 118 (2004) 133-173; K. Nehring, Capacities and probabilistic beliefs: a precarious coexistence, Math. Soc. Sci. 38 (1999) 197-213; J. Zhang, Subjective, ambiguity, expected utility and Choquet expected utility, Econ. Theory 20 (2002) 159-181] in the context of Maximin Expected Utility (MEU). We show that each definition of unambiguous events produces certain restrictions on the set of priors, and completely characterize each definition in terms of the properties it imposes on the MEU functional. We apply our results to two open problems. First, in the context of MEU, we show the existence of a fundamental incompatibility between the axiom of “Small unambiguous event continuity” (Epstein and Zhang, 2001) and the notions of unambiguous event due to Zhang (2002) and Epstein and Zhang (2001). Second, we show that, in the context of MEU, the classes of unambiguous events according to either Zhang (2002) or Epstein and Zhang (2001) are always λ-systems. Finally, we reconsider the various definitions in light of our findings, and identify some new objects (Z-filters and EZ-filters) corresponding to properties which, while neglected in the current literature, seem relevant to us.     

Testing Commitment Models of Monetary Policy in China

In the past decade Chinese inflation was not high on average, but it was quite volatile. Back in the 1980s and 1990s, high inflation was a very real problem. What explains the inflationary dynamics in China? In particular, does monetary policy account for the substantial run-ups of inflation, followed by the equally substantial dis-inflation? In the absence of commitment technologies, the monetary authorities may create surprise inflation to achieve higher growth, while private agents would anticipate that and adjust their decisions accordingly, leading to accelerated inflation without a real impact. Do these types of simple time-inconsistency models of monetary policy explain the dynamic pattern of inflation in China? I show that the long-run and short-run restrictions imposed by discretionary policy, when the time-inconsistent policymaker has a desire to push output above potential, are largely rejected by the data. The estimates of the inflation bias under discretion when the policymaker is asymmetrically averse to recessions are not statistically significant either. The analysis contributes to the understanding of Chinese monetary policy and its inflationary implications and also points to the need of further investigation of inflationary behavior during the economic transition.     

Pre-play communication with forgone costly messages: experimental evidence on forward induction

We experimentally study optional costly communication in Stag-Hunt games. Prior research demonstrates that efficient coordination is difficult without a communication option but obtains regularly with mandatory costless pre-play messages. We find that even small communication costs dramatically reduce message use when communication is optional, but efficient coordination can occur with similar frequency as under costless communication. These findings can be accounted for by formalizations of forward induction that take Nash equilibrium as a reference point (such as Kohlberg and Mertens in Econometrica 54: 1003–1037, 1986; Govindan and Wilson in Econometrica 77: 1–28, 2009), while formalizations that only appeal to (higher-order) knowledge of rationality remain silent in this environment.     

Disappearing private reputations in long-run relationships

For games of public reputation with uncertainty over types and imperfect public monitoring, Cripps et al. [Imperfect monitoring and impermanent reputations, Econometrica 72 (2004) 407-432] showed that an informed player facing short-lived uninformed opponents cannot maintain a permanent reputation for playing a strategy that is not part of an equilibrium of the game without uncertainty over types. This paper extends that result to games in which the uninformed player is long-lived and has private beliefs, so that the informed player's reputation is private. The rate at which reputations disappear is uniform across equilibria and reputations also disappear in sufficiently long discounted finitely repeated games.     

Determining the number of factors after stationary univariate transformations

A very common practice when extracting factors from non-stationary multivariate time series is to differentiate each variable in the system. As a consequence, the ratio between variances and the dynamic dependence of the common and idiosyncratic differentiated components may change with respect to the original components. In this paper, we analyze the effects of these changes on the finite sample properties of several procedures to determine the number of factors. In particular, we consider the information criteria of Bai and Ng (Econometrica 70(1):191–221, 2002), the edge distribution of Onatski (Rev Econ Stat 92(4):1004–1016, 2010) and the ratios of eigenvalues proposed by Ahn and Horenstein (Econometrica 81(3):1203–1227, 2013). The performance of these procedures when implemented to differentiated variables depends on both the ratios between variances and dependencies of the differentiated factor and idiosyncratic noises. Furthermore, we also analyze the role of the number of factors in the original non-stationary system as well as of its temporal and cross-sectional dimensions. Finally, we implement the different procedures to determine the number of common factors in a system of inflation rates in 15 euro area countries.     

Optimal use of correlated information in mechanism design when full surplus extraction may be impossible

We study the mechanism design problem when the principal can condition the agent's transfers on the realization of ex post signals that are correlated with the agent's types. Crémer and McLean [Econometrica 53(1985) 345-361; 56(1988) 1247-1257], McAfee and Reny [Econometrica 60(2)(1992) 395-421], and Riordan and Sappington [J. Econ. Theory, 45(1988) 189-199] studied situations where the signals are such that full surplus can be extracted from every agent type. We study optimal utilization of the signals when there are fewer signals than types and the Riordan and Sappington conditions do not always hold. For some special cases, we show the level of surplus that can be extracted, and identify the agent types who obtain rent.