In Defense of Usury Laws

Usury law is often criticized by economists for curtailing lending and thus creating deadweight costs. This paper shows that if moral hazard leads to credit rationing, a just-binding usury law creates a deadweight gain.  This property also holds in most market-clearing equilibria. Independent of social insurance benefits, or curbing present-biased preferences, interest rate caps have merit.     

Decision theory analysis of audit discovery sampling*

Abstract. Discovery sampling is a frequently used auditing technique. The objective of discovery sampling is to decide whether to accept or reject an audit population for which acceptance is appropriate only if the occurrence rate of serious errors is very low. This objective is met by auditing a sample and accepting only if the sample is free of serious errors. This paper first develops a Bayesian decision theory approach to the discovery sampling problem. Using this approach the auditor optimizes sampling effort according to a decision model that explicitly includes such factors as risk of failure of accepting too high an error rate, losses from wrong decisions, sampling costs, and prior distribution of the error rate. The form of the loss function used includes both linear and quadratic loss functions as special cases. Methods and formulas applicable to various prior distributions for the error rate are obtained. Detailed results are derived for two state-prior and gamma-prior distributions. A minimax approach that removes the need to elicit a complete prior distribution is then developed. Explicit formulas are obtained for both the admissible sample size range and for the minimax sample size. A comparison of results indicates that the minimax approach is nearly as efficient as approaches that require elicitation of prior problem rate distributions. Further analysis generalizes the methods by showing that for the Bayesian and minimax methods, analytical results can be derived for various forms of loss functions. Résumé. Le sondage de dépistage est une technique fréquemment utilisée en vérification qui a pour objectif de déterminer s'il faut accepter ou rejeter une population pour laquelle l'acceptation n'est appropriée que si la fréquence d'erreurs graves est très faible. L'objectif est réalisé au moyen de la vérification d'un échantillon et de son acceptation seulement si l'échantillon est exempt d'erreurs graves. L'auteur met d'abord au point une méthode inspirée de la théorie bayesienne de la décision, adaptée au problème du sondage de dépistage. En utilisant cette méthode, le vérificateur optimise le travail d'échantillonnage conformément à un modèle de décision qui comprend explicitement des facteurs tels que le risque d'échec ou le risque d'acceptation d'un taux d'erreur trop élevé, les pertes attribuables à de mauvaises décisions, les coûts d'échantillonnage et la distribution a priori du taux d'erreur. Des formes de fonction de perte utilisées, celles linéaires et quadratiques constituent des cas spéciaux. L'auteur obtient des méthodes et des formules applicables aux diverses distributions a priori du taux d'erreur. Il dérive les résultats analytiques pour les distributions a priori binômiale et gamma. L'auteur met ensuite au point une méthode minimax supprimant la nécessité d'obtenir une distribution a priori complète. Il obtient des formules explicites pour la fourchette de tailles d'échantillons admissibles ainsi que pour la taille de l'échantillon minimax. Une comparaison des résultats indique que la méthode minimax est presque aussi efficace que les méthodes qui exigent l'obtention de distributions a priori de taux d'erreurs. Le prolongement de l'analyse permet de généraliser les méthodes; il démontre en effet que pour les méthodes bayesienne aussi bien que minimax, les résultats analytiques peuvent être dérivés pour diverses formes de fonctions de perte.     

Explaining House Price Dynamics: Isolating the Role of Nonfundamentals

This paper examines the role of nonfundamentals‐based sentiment in house price dynamics, including the well‐documented volatility and persistence of house prices during booms and busts. To measure and isolate sentiment's effect, we employ survey‐based indicators that proxy for the sentiment of three major agents in housing markets: home buyers (demand side), home builders (supply side), and lenders (credit suppliers). After orthogonalizing each sentiment measure against a broad set of fundamental variables, we find strong and consistent evidence that the changing sentiment of all three sets of market participants predicts house price appreciation in subsequent quarters, above and beyond the impact of changes in lagged price changes, fundamentals, and market liquidity. More specifically, a one‐standard‐deviation shock to market sentiment is associated with a 32–57 basis point increase in real house price appreciation over the next two quarters. These price effects are large relative to the average real price appreciation of 71 basis points per quarter observed over the full sample period. Moreover, housing market sentiment and its effect on real house prices is highly persistent. The results also reveal that the dynamic relation between sentiment and house prices can create feedback effects that contribute to the persistence typically observed in house price movements during boom and bust cycles.     

SCHOOL CHOICE: SUPPORTERS AND OPPONENTS

We examine the attitudes of Ohio homeowners about school choice, which includes open enrollment programs, school vouchers, tuition tax credits, and charter schools. Previous studies examine more limited forms of choice and investigate fewer possible influences. Overall we report at least five new findings and five findings that contradict previous studies. We find the strongest predictors of opposition for school choice are people having graduate degrees and living in high‐performing public school districts. We find people living in blue collar areas and using private schools to be the strongest predictors of support. Males tend to oppose choice and African Americans support it. We find no role for income, the convenience of alternative schools, or the protection of house values in support for school choice. Overall we report at least five new findings and five findings that contradict previous studies. (JEL H44, I22)     

Presidential Address: Pension Policy and the Financial System

In this paper, I examine the effect of pension policy on the structure of financial systems around the world. In particular, I explore the hypothesis that policies that promote pension savings also promote the development of capital markets. I present a model that endogenizes the extent to which savings are intermediated through banks or capital markets, and derive implications for corporate finance, household finance, banking, and the size of the financial sector. I then present a number of facts that are broadly consistent with the theory and examine a variety of alternative explanations of my findings.     

Growth,Industrialization, and the Intergenerational Correlation of Advantage

The shift from feudalism to industrial capitalism was generally accompanied by an increase in social mobility. We ask whether such an increase has occurred in a developing nation currently undergoing rapid industrialization, Indonesia. It has, at least as measured by a declining intergenerational correlation of education. To highlight the effects of economic growth on intergenerational mobility, we contrast Indonesia's experience with that of Bangladesh, where industrialization has proceeded more slowly and the correlation between parents’ and children's education has been roughly stable. We also examine potential causal channels for the rising educational mobility we find in Indonesia, but cannot identify specific pathways related to above‐average school building or rapid industrialization in a region.     

CONTRACTING FOR AN INNOVATION UNDER BILATERAL ASYMMETRIC INFORMATION*

We analyze licensing contracts between informed innovators and developers exerting profit‐increasing effort. Those contracts must simultaneously induce innovators to convey information on the value of their ideas, while inducing developers to exert effort and protecting the innovators' intellectual property rights. We show that the best innovators signal themselves by taking more royalties even if it reduces the developers' share of returns and their incentives. Moreover, royalties are more likely to be used when property rights are easy to enforce and pre‐contractual evidence on innovation quality is hard to produce.