Belief heterogeneity and survival in incomplete markets

In complete markets economies (Sandroni in Econometrica 68:1303–1341, 2000), or in economies with Pareto optimal outcomes (Blume and Easley in Econometrica 74:926–966, 2006), the market selection hypothesis holds, as long as traders have identical discount factors. Traders who survive must have beliefs that merge with the truth. We show that in incomplete markets, regardless of traders’ discount factors, the market selects for a range of beliefs, at least some of which do not merge with the truth. We also show that impatient traders with incorrect beliefs can survive and that these incorrect beliefs impact prices. These beliefs may be chosen so that they are far from the truth.     

Consumption dynamics in general equilibrium: A characterisation when markets are incomplete

We introduce a methodology for analysing infinite horizon economies with two agents, one good, and incomplete markets. We provide an example in which an agent's equilibrium consumption is zero eventually with probability one even if she has correct beliefs and is marginally more patient. We then prove the following general result: if markets are effectively incomplete forever then on any equilibrium path on which some agent's consumption is bounded away from zero eventually, the other agent's consumption is zero eventually—so either some agent vanishes, in that she consumes zero eventually, or the consumption of both agents is arbitrarily close to zero infinitely often. Later we show that (a) for most economies in which individual endowments are finite state time homogeneous Markov processes, the consumption of an agent who has a uniformly positive endowment cannot converge to zero and (b) the possibility that an agent vanishes is a robust outcome since for a wide class of economies with incomplete markets, there are equilibria in which an agent's consumption is zero eventually with probability one even though she has correct beliefs as in the example. In sharp contrast to the results in the case studied by Sandroni (2000) [29] and Blume and Easley (2006) [8] where markets are complete, our results show that when markets are incomplete not only can the more patient agent (or the one with more accurate beliefs) be eliminated but there are situations in which neither agent is eliminated.     

Asymmetric information and survival in financial markets

Summary. In the evolutionary setting for a financial market developed by Blume and Easley (1992), we consider an infinitely repeated version of a model á la Grossman and Stiglitz (1980) with asymmetrically informed traders. Informed traders observe the realisation of a payoff relevant signal before making their portfolio decisions. Uninformed traders do not have direct access to this kind of information, but can partially infer it from market prices. As a counterpart for their privileged information, informed traders pay a per period cost. As a result, information acquisition triggers a trade-off in our setting. We prove that, so long as information is costly, uninformed traders survive.JEL Classification Numbers: D50, D82, G14.I am deeply indebted to Luca Anderlini for his helpful guidance. I also benefited from discussion with Larry Blume, David Easley, Jayasri Dutta, Thorsten Hens, Hamid Sabourian, Klaus Reiner Schenk-Hoppé and Hyun Song Shin. Useful comments came from an anonymous referee and participants to seminars in Barcelona, Bielefeld, Cambridge, Manchester, Oxford, Rotterdam, Venice, Zurich, to the PhD Awards Italian tour in Rome, Naples, Padova and Milan, and to ESEM99 and EEA99 in Santiago de Compostela.     

Market power, survival and accuracy of predictions in financial markets

In a standard General Equilibrium framework, we consider an agent strategically using her large volume of trade to influence asset prices to increase her consumption. We show that, as in Sandroni (Econometrica 68:1303–1341, 2000) for the competitive case, if markets are dynamically complete and some general conditions on market preferences are met then this agent’ long-run consumption will vanish if she makes less accurate predictions than the market, and will maintain her market power otherwise. We thus argue that the Market Selection Hypothesis extends to this situation of market power, in contrast to Alchian (J Pol Econ 58:211–221, 1950) and Friedman (Essays in Positive Economics, University of Chicago Press, Chicago, 1953) who claimed that this selection was solely driven by the competitiveness of markets. I would like to thank T. Hens, A. Kirman and A. Sandroni for many stimulating conversations and encouragements. Two anonymous referees also provided very valuable comments.     

Fiscal rules and extrinsic uncertainty

Summary This paper analyzes the effect of two fiscal policy regimes on the set of equilibria. A general equilibrium model with public goods is used to re-examine Friedman's [9] proposal for fiscal reform. The issue is whether a constraint upon fiscal policy requiring budget balance under all contingencies increases the stability of the economy. Stability is modelled in terms of neutralizing extrinsic uncertainty or sunspots. The government consists of bureaus providing public goods. The budgetary rules entail fixed shares of revenues and arrangements for budget balancing. Existence of equilibrium and properties of the equilibrium set are established. The Friedmanite rules permit extrinsic uncertainty to affect outcomes, while a policy that allows the bureaus greater discretion in the pursuit of their objectives neutralizes it.This paper is based on Goenka [11]. I thank Larry Blume, David Easley, Roger Guesnerie, Christophe Préchac, Bruce Smith, and Steve Spear for helpful comments. I would especially like to thank Karl Shell for many discussions and advice, and Michael Woodford whose detailed comments have sharpened the paper. This paper has benefitted from presentations at Buffalo, Cornell, VPI, CMU, LSE, and the 1991 European meetings of the Econometric Society. Research support from N.S.F. Grant SES-8606944 and the Center for Analytic Economics at Cornell University is gratefully acknowledged. All errors are mine.     

Decentralizing lottery allocations in markets with indivisible commodities

Summary In economies with indivisible commodities, consumers tend to prefer lotteries in commodities. A potential mechanism for satisying these preferences is unrestricted purchasing and selling of lotteries in decentralized markets, as suggested in Prescott and Townsend [Int. Econ. Rev.25, 1–20]. However, this paper shows in several examples that such lottery equilibria do not always exist for economies with finitely many consumers. Other conditions are needed. In the examples, equilibrium and the associated welfare gains are realized if consumptions are bounded or if lotteries are based upon a common sunspot device as defined by Shell [mimeo, 1977] and Cass and Shell [J. Pol. Econ.91, 193–227]. The paper shows that any lottery equilibrium is either a Walrasian equilibrium or a sunspot equilibrium, but there are Walrasian and sunspot equilibria that are not lottery equilibria.This paper is based on Chapter 3 of my doctoral dissertation, written while I was a student at Cornell University. I thank Larry Blume, Yue Yun Chen, David Easley, Aditya Goenka, John Marshall, Bruce Smith, John Wooders and an anonymous referee. I am particularly grateful to Karl Shell and Cheng-Zhong Qin. I thank the Academic Senate at UCSB for financial support.     

An empirical comparison of implied tree models for KOSPI 200 index options

This paper compares implied tree models for KOSPI 200 index options with regards to the pricing and hedging performance. With Cox, Ross, and Rubinstein's [Cox, J., Ross, S., & Rubinsteinm, M., 1979. Option pricing: A simplified approach. Journal of Financial Economics, 7, 229–263] standard binomial tree (SBT) model as a benchmark, we analyzed three models: Rubinstein's [Rubinstein, M., 1994. Implied binomial trees. Journal of Finance, 49, 771–818] implied binomial tree (IBT), Jackwerth's [Jackwerth, J. C., 1997. Generalized binomial trees. Journal of Derivatives, 5, 7–17] generalized binomial tree (GBT), and Derman and Kani's [Derman, E., & Kani, I., 1994. Riding on a smile. Risk, 7, 32–39] implied volatility tree (IVT) models. The SBT model, the simplest, shows the best performance. Moreover, the delta-hedged strategy in all of the binomial models generates, on average, negative gains. This finding, consistent with the findings by Bakshi and Kapadia [Bakshi, G., & Kapadia, N., 2003. Delta-hedged gains and the negative market volatility risk premium. Review of Financial Studies, 16, 527–566], indicates the existence of a negative market volatility risk premium.     

Optimal guessing: Choice in complex environments

In this paper, we extend the analysis of our earlier work on boundedly rational learning in an i.i.d. setting [Easley and Rustichini, Econometrica 67 (1999) 1157-1184] to complex decision problems. We show that the axioms from our earlier analysis can be applied in this more complex setting, and along with some new axioms, they asymptotically yield expected utility maximization. Perhaps most important is our demonstration of a simple procedure that insures expected payoff maximization no matter what Markov process the underlying process on states follows. We view this result as providing a positive learning result for all worlds in which learning is possible.     

On the effects of emission standards as a non-tariff barrier to trade in the case of a foreign Bertrand duopoly: A note

Employing a model of an environmentally differentiated product market, we analyze how an emission regulation as non-tariff barriers to trade affects imports, the environment, and welfare in the case of a foreign Bertrand duopoly. Related to this issue, we reconsider the result of Moraga-González and Padrón-Fumero [Moraga-González, J.L., Padrón-Fumero, N., 2002. Environmental policy in a green market. Environmental and Resource Economics 22, 419–447] that a strict emission standard on a dirtier product degrades the environment and reduces the net social surplus associated with the valuation of environmental damage, if the marginal social valuation of environmental damage is larger. On the other hand, we show that a strict emission standard on a cleaner product always improves the environment and the net social surplus associated with the valuation of environmental damage.     

Stackelberg financial-leader in insider trading model

In this paper, we extend the Jain-Mirman [Jain, N., & Mirman, L. (2000). Real and financial effects of insider trading with correlated signals. Economic Theory, 16, 333–353, Jain, N., & Mirman, L. (2002). Effects of insider trading under different market structures. The Quarterly Review of Economics and Finance, 42, 19–39] and the Daher-Mirman [Daher, W., & Mirman, L. (2006). Cournot duopoly and insider trading with two insiders. The Quarterly Review of Economics and Finance, 46, 530–551, Daher, W., & Mirman, L. (2007). Market structure and insider trading. International Review of Economics and Finance, 16, 306–331] papers on competition, and postulate that the competition among the insiders in the financial market be Stackelberg. However, an owner high in the organizational hierarchy, who designs manager compensation mechanisms and chooses a manager to serve his purpose, should have information on the manager's reaction and act as a Stackelberg leader in the financial sector. We show that owner's profit can definitely enlarged while the manager's profits may decrease or increase depending on the variances in the two sectors, which are the exogenous parameters.     

Information–driven trading at the Prague Stock Exchange: Evidence from Intra–Day Data

Many observers argue that informed and insider trading is widespread in the emerging financial markets of transition countries, yet rigorous treatment of this issue has been virtually non–existent. The current paper estimates the extent of informed trading on the Prague Stock Exchange (PSE) using intra–day transaction data. Our estimates confirm that the average share of informed trading is equal to 0.32, which is high relative to developed markets and varies considerably among stocks. Using the Easley et al. (1996) approach on the very best segment of the PSE we obtained a high average probability of informed trading. Since data used in this study cover the period after the major attempts to improve market regulations, our results indicate that the PSE needs further strengthening to recover credibility and to become a real source of corporate financing. JEL classification: G14, G15.     

Market power and exchange rate pass-through

In this paper we provide new empirical evidence on the relationship between market power, as measured by market share, and incomplete exchange rate pass-through. The role of market power is examined in the context of a Cournot model, which is estimated with data relating to Japan's presence in the US market. To test for the existence of possible aggregation biases due to sectoral heterogeneity, estimations are carried out on time series data for the total economy and the manufacturing sector and on panel data for five manufacturing industries at the three-digit level of classification, using the Johansen multivariate cointegration technique and the recently developed by [Larsson, R., Lyhagen, J., & Lothgren, M. (2001). Likelihood-based cointegration tests in heterogeneous panels. Econometrics Journal, 4, 109–142] multivariate panel cointegration technique. Hypotheses about the degree of pass-through are tested as restrictions on estimated equilibrium pricing equations and robustness tests are performed. The empirical results indicate that Japanese firms have market power and this validates the use of an imperfect competition model. However, it appears that market power is not the only element on which to base the analysis of the incomplete exchange rate pass-through by Japanese firms.     

Can people learn rational expectations?

In this note the stability of the rational expectations equilibrium for the Foster and Frierman (1990) version of the Blume and Easley (1982) model is investigated under the assumption that the learning mechanism used by economic agents is based on a selection mechanism on a class of competing models having a physical meaning for the agent and not on the interpolation of models having no clear physical meaning, as it is often the case in the literature on learning rational expectations. It is found that, under the standard assumption that the rational expectations model is in the information set of the uninformed trader no matter his degree of rationality, convergence to it is less likely the higher the uninformed agent's degree of rationality, in a sense to be specified in the paper. Some comments on the result are also provided.     

Model uncertainty and liquidity

Extreme market outcomes are often followed by a lack of liquidity and a lack of trade. This market collapse seems particularly acute for markets where traders rely heavily on a specific empirical model such as in derivative markets like the market for mortgage backed securities or credit derivatives. Moreover, the observed behavior of traders and institutions that places a large emphasis on “worst-case scenarios” through the use of “stress testing” and “Value-at-Risk” seems different than Savage expected utility would suggest. In this paper, we capture model-uncertainty using an Epstein and Wang [Epstein, L.G., Wang, T., 1994. Intertemporal asset pricing under Knightian uncertainty. Econometrica 62, 283–322] uncertainty-averse utility function with an ambiguous underlying asset-returns distribution. To explore the connection of uncertainty with liquidity, we specify a simple market where a monopolist financial intermediary makes a market for a propriety derivative security. The market-maker chooses bid and ask prices for the derivative, then, conditional on trade in this market, chooses an optimal portfolio and consumption. We explore how uncertainty can increase the bid–ask spread and, hence, reduces liquidity. Our infinite-horizon example produces short, dramatic decreases in liquidity even though the underlying environment is stationary. We show how these liquidity crises are closely linked to the uncertainty aversion effect on the optimal portfolio. Effectively, the uncertainty aversion can, at times, limit the ability of the market-maker to hedge a position and thus reduces the desirability of trade, and hence, liquidity.     

关于我国股市知情交易水平及其性质的实证研究

基于Easley、Hvidkjaer和O'Hara的序贯交易模型与PIN (Probability of Information-based Trading,基于信息的交易比率)指标对我国股市知情交易情况进行的实证分析研究结果表明:(1)我国股市信息不对称程度较高;(2)由于知情交易者利用坏消息的能力有限且流动性交易水平较高,我国股市知情交易比率并不太高;(3)知情交易比率与后续期间股票收益率的负相关性,表明我国股市中市场操控型知情交易比较严重.因此,我们认为应进一步完善上市公司的信息披露制度,降低投资者之间的信息不对称程度,同时确保流动性投资者参与股市的积极性;在引入做空机制时应慎重考虑和综合权衡,避免不适当地增加流动性投资者所承担的逆向选择风险水平,降低股市的流动性供给和风险分散功能;证券市场监管部门应进一步加强对异常交易活动的监控,加大对市场操纵行为的打击力度,以确保我国证券市场的健康发展.     

Exactly what happens after the Anscombe–Aumann race?

This paper derives a representation of preferences for a choice theory with vague environments; vague in the sense that the agent does not know the precise lotteries over outcomes conditional on states. Instead, he knows only a possible set of these lotteries for each state. Thus, this paper’s main departure from the standard subjective expected utility model is to relax an assumption about the environment, rather than weakening the axiomatic structure. My model is consistent with the behavior observed in the Ellsberg experiment. It can capture the same type of behavior as the multiple priors models, but can also result in behavior that is different from both the behavior implied by standard subjective expected utility models and the behavior implied by the multiple priors models. This paper is a revised chapter of my Ph.D. dissertation at Cornell University. I am very grateful to David Easley for extensive comments and suggestions. I also thank Larry Blume, Ani Guerdjikova, Edi Karni, Ted O’Donoghue, Maureen O’Hara, Jacob Sagi, seminar participants at the University of Copenhagen, Cornell University, ESEM 2006, Fuqua—Duke University, FUR 2006, Johns Hopkins University, Purdue University, Queen’s University, the University of Warwick, the associate editor, and an anonymous referee for comments and suggestions.     

Living with ambiguity: prices and survival when investors have heterogeneous preferences for ambiguity

This paper investigates asset prices and the long run wealth of investors in an asset market populated by investors who have heterogeneous preferences over risk and ambiguity. In a dynamic setting I characterize conditions under which investors who are averse to ambiguity will have an effect on long run asset prices. If ambiguity averse investors always believe that the true distribution could be wrong in many possible directions then a necessary condition for their survival is that the market exhibit no aggregate risk, a condition not met by many asset pricing models of interest. However, unlike investors with irrational beliefs, there do exist markets in which ambiguity averse investors survive. I have greatly benefitted from conversations with David Easley, Karl Shell, Ani Guerdjikova, Val Lambson, Kristian Rydqvist, Liyan Yang, Josh Teitelbaum and Jayant Ganguli as well as seminar participants at Cornell University and the Midwest Economic Theory Meetings. I am grateful to the Solomon Fund for Decision Research at Cornell University for support.     

Durability choice with differentiated products

In a two-period setting we explore the impact of a related non-durable good or service on a monopolists’ choice of product durability. We show that a renting firm will provide the social efficient cost-minimizing durability independent of the related non-durable product. Thus Swan’s [Swan, P., 1970. Durability of consumption goods. American Economic Review 60, 884–894; Swan, P., 1971. The durability of goods and the regulation of monopoly. Bell Journal of Economics and Management Science 2, 347–357] market independence result can be extended to include durable goods renters that manufacture related non-durables. This finding, however, does not extend to sales markets. With sales, the monopolist will practice planned obsolescence (manufacture goods with uneconomically short lives). We find that planned obsolescence is maximized when the related output is highly complementary with the durable good. This indicates that in durable products markets, such as the electronics industry, public policies that encourage the adoption of complements for the durable may well lead to a less efficient durability choice.     

Minimally acceptable altruism and the ultimatum game

I suppose that people react with anger when others show themselves not to be minimally altruistic. With heterogeneous agents, this can account for the experimental results of ultimatum and dictator games. Moreover, it can account for the surprisingly large fraction of individuals who offer an even split with parameter values that are more plausible than those that are required to explain outcomes in these experiments with the models of Levine [Levine, D.K., 1998. Modeling altruism and spitefulness in experiments. Review of Economic Dynamics 1, 593–622], Fehr and Schmidt [Fehr, E., Schmidt, K.M., 1999. A theory of fairness, competition and cooperation. Quarterly Journal of Economics 114, 817–868], Dickinson [Dickinson, D.L., 2000. Ultimatum decision making: a test of reciprocal kindness. Theory and Decision 48, 151–177] and Bolton and Ockenfels [Bolton, G.E., Ockenfels, A., 2000. ERC: a theory of equity, reciprocity, and competition. American Economic Review 90, 166–193].     

Market access for sale

This paper focuses on the links between foreign lobbying and preferential market access granted by the United States' government to exporters in the rest of the Americas. We first develop a simple framework based on Grossman and Helpman [Grossman, G., Helpman, E., 1994. Protection for sale. American Economic Review 84 (4) 833–850.] to explain how lobbying by foreign firms affects their preferential access to the United States market. We then estimate the model using data on tariff preferences and lobby contributions for the 34 countries in the region. Empirical results suggest that foreign lobbying is an important force behind preferential market access to the United States. The structural estimates indicate that the weight given to foreign lobby contributions in the United States' government objective function is five times higher than the weight granted to tariff revenue forgone due to preferences. Thus, our results indicate that market access is up for sale and foreign lobbies are buying it.