Bayesian Hypothesis Testing: a Reference Approach

For any probability model M={p(x|θ, ω), θεΘ, ωεΩ} assumed to describe the probabilistic behaviour of data xεX, it is argued that testing whether or not the available data are compatible with the hypothesis H₀={θ=θ₀} is best considered as a formal decision problem on whether to use (a₀), or not to use (a₀), the simpler probability model (or null model) M₀={p(x|θ₀, ω), ωεΩ}, where the loss difference L(a₀, θ, ω) –L(a₀, θ, ω) is proportional to the amount of information δ(θ₀, ω), which would be lost if the simplified model M₀ were used as a proxy for the assumed model M. For any prior distribution π(θ, ω), the appropriate normative solution is obtained by rejecting the null model M₀ whenever the corresponding posterior expectation ∫∫δ(θ₀, θ, ω)π(θ, ω|x)dθdω is sufficiently large. Specification of a subjective prior is always difficult, and often polemical, in scientific communication. Information theory may be used to specify a prior, the reference prior, which only depends on the assumed model M, and mathematically describes a situation where no prior information is available about the quantity of interest. The reference posterior expectation, d(θ₀, x) =∫δπ(δ|x)dδ, of the amount of information δ(θ₀, θ, ω) which could be lost if the null model were used, provides an attractive nonnegative test function, the intrinsic statistic, which is invariant under reparametrization. The intrinsic statistic d(θ₀, x) is measured in units of information, and it is easily calibrated (for any sample size and any dimensionality) in terms of some average log‐likelihood ratios. The corresponding Bayes decision rule, the Bayesian reference criterion (BRC), indicates that the null model M₀ should only be rejected if the posterior expected loss of information from using the simplified model M₀ is too large or, equivalently, if the associated expected average log‐likelihood ratio is large enough. The BRC criterion provides a general reference Bayesian solution to hypothesis testing which does not assume a probability mass concentrated on M₀ and, hence, it is immune to Lindley's paradox. The theory is illustrated within the context of multivariate normal data, where it is shown to avoid Rao's paradox on the inconsistency between univariate and multivariate frequentist hypothesis testing.     

Sovereign default: Which shocks matter?

This paper analyses a small open economy that wants to borrow from abroad, cannot commit to repay debt but faces costs if it decides to default. The model generates analytical expressions for the impact of shocks on the incentive compatible level of debt. Debt reduction generated by severe output shocks is no more than a couple of percentage points. In contrast, shocks to world interest rates can substantially affect the incentive compatible level of debt.     

Trade, technology, and the rise of the service sector: The effects on US wage inequality

This paper uses a multi-sector version of the Ricardo-Viner model of international trade to quantify empirically the effects of technological changes, international trade, changes in the sectoral composition of the economy, and other factors on the US wage premium. The main finding of the paper is that changes in the sectoral composition of the economy were the most important force behind the widening of the wage gap, accounting for about 60% of the relative increase in wages of skilled workers between 1970 and 1996. In essence, capital was reallocated to sectors where it is relatively complementary to skilled workers.     

Reluctant regulation

We study the effect of state ownership on the market-to-book ratios of publicly traded European utilities from 1994 to 2005. We find that when the company is subject to independent regulation, state ownership seems positively associated with firm value. This relation tends to appear in countries where weak checks and balances and political fragmentation do not constrain the power of the executive. Our results suggest that, where political institutions are weak, politicians may influence regulatory agencies in order to benefit state-owned firms.     

The automatic reaction of the Italian government budget to fundamentals: an econometric analysis

The paper offers a new estimate of the sensitivity of Italy's primary budget balance to macroeconomic variables. The analysis has distinguishing features: detailed itemization of public finance aggregates; close attention to the statistical properties of the time series; and joint estimation of elasticities with respect to both real GDP and inflation. First, the economic variables driving the automatic component were chosen. Second, when possible, a macroeconomic base was associated with each public finance item. Third, each tax base was regressed on the driving economic variables. Fourth, each budget item that was supposed to include an automatic component was regressed either on its own base or directly on the economic variables affecting the automatic components. The effects on public budget are simulated to investigate the consequences of a change in nominal and real GDP.     

Do droughts have long-term effects on water consumption? Evidence from the urban area of Barcelona

This article examines the long-term effects of droughts on water consumption using data of municipalities of the urban area of Barcelona. Two important characteristics of the sample of municipalities are the relatively low water consumption in the pre-drought period and the fact that indoor uses are clearly predominant. Controlling for prices, income and various socio-demographic factors, we find a reduction in water consumption not only during the drought episode but also in subsequent periods. These permanent reductions in water use may be explained by household behavioural changes, technological changes or structural water policy changes.     

Risk and wealth in a model of self-fulfilling currency attacks

Market participants’ risk attitudes, wealth and portfolio composition influence their positions in a pegged foreign currency and, therefore, may have important effects on the sustainability of currency pegs. This paper analyzes such effects in a global game model of currency crises with continuous action choices, generating a rich set of theoretical comparative static predictions related to often discussed but rarely modelled accounts of currency attacks. The model can be solved in closed form and the methods could be used to study other economic issues in which coordination and risk aversion play important roles.     

Capital Structure and Regulation: Do Ownership and Regulatory Independence Matter?

We study the effect of ownership structure and regulatory independence on the interaction between capital structure and regulated prices using a comprehensive panel data of publicly traded European utilities. We find that firms in our sample tend to have a higher leverage if they are privately controlled and regulated by an independent regulatory agency. Moreover, the leverage of these firms has a positive and significant effect on their regulated prices, but not vice versa. Our results are consistent with the theory that privately controlled regulated firms use leverage strategically to obtain better regulatory outcomes.     

An Empirical Analysis of the Relative Efficiency of Policy Instruments to Reduce Nitrate Water Pollution in the U.S. Southern High Plains

This paper develops a modeling framework for evaluating alternative water quality protection policies. The framework integrates the EPIC-PST crop growth/chemical transport model and a mathematical programming model. The framework is applied to the evaluation of four water quality policies in the southern high plains of the United States:
• restrictions on per-acre nitrogen use,
• taxes on nitrogen use,
• taxes on irrigation water use, and
• incentives to convert conventional irrigation systems to modem irrigation technology. The results indicate that producers would make a variety of adjustments in responding to these policies. Important responses might include reductions in nitrogen and water use, crop substitution, removal of land from crop production and conversion from irrigated to dryland production. These four policies are evaluated based on changes in farm income and social welfare. The irrigation system conversion incentive clearly outperforms other policies from both society's and producers points of view. Producers would prefer nitrogen use restrictions to nitrogen or water use taxes because farm income would be reduced less under the restrictions than under the taxes. Nitrogen use taxes, however, are more desirable than nitrogen use restrictions from society's point of view.     

A method to assess the eco-efficiency of a public bus transportation service

Brazilian Public Bus Transportation Service transports over 34.4 million passengers daily using approximately 107,000 urban buses. This service costs millions of dollars annually to the municipality and emits several pollutants to the atmosphere. Therefore, this paper proposes a method to assess the eco-efficiency of a Public Bus Transportation Service. The proposed method was tested in a medium-sized urban region in Brazil. Different scenarios representing changes in the vehicles engines and fuels were tested and analyzed. Six eco-efficiency indicators regarding emissions and fuel consumption were proposed to assess which mix of engines and fuels would bring the greatest eco-efficiency. The results were compared to targets based on Brazilian regulation and showed that the renewal of the fleet is necessary to meet the environmental targets, while also achieving fuel costs reduction.