Creating a Testable, Estimable Model to Inform Our Response to the Test-Score Gap Crisis

The test-score gap between black and white students should be seen as a crisis. We propose a testable model based on readily available data that will allow us to estimate the impact and interrelationships of a multitude of factors that may be partially responsible for the problem. The estimation of this model will require the joint efforts of experts in many areas of education as well as of experts in multilevel structural equation modeling.     

The European Union’s Constitutional Crisis—Causes and Consequences

The rejection of the treaty establishing a European constitution by French and Dutch voters has thrown the EU into a deep crisis. What developments in the EU contributed to these referenda results? What consequences are to be drawn for the continuation of integration and the integration goal, the governance of the EU-25 and the further planned enlargements? What flaws are there in the present draft constitution and how can these be dealt with?     

Asset allocation over the life cycle: How much do taxes matter?

We study the welfare effect of tax-optimizing portfolio decisions in a life cycle model with unspanned labor income and realization-based capital gain taxation. For realistic parameterizations of our model, certainty equivalent welfare gains from fully tax-optimized portfolio decisions are less than 2% of present financial wealth and lifetime income compared to a heuristic portfolio policy ignoring the taxation of profits (capital gains, interest and dividend payments). Compared to a heuristic portfolio policy that only ignores the realization-based feature of capital gain taxation and instead assumes mark-to-market taxation, these gains are less than 0.5%. That is, our work provides a justification for ignoring taxes in life cycle portfolio choice problems – a wide-spread assumption in that literature. However, if capital gains are forgiven at death (as in the U.S.), investors with strong bequest motives face substantial welfare costs when not tax-optimizing their portfolio decisions towards the end of the life cycle.     

AGRICULTURE IN THE URUGUAY ROUND: AMBITIONS AND REALITIES

Agricultural trade policies are basically a function of domestic policy considerations which have produced high levels of support in many countries. New policy instruments such as direct payments, which are more demanding in terms of information costs but which distort resource allocation less, are becoming more attractive. Unilateral liberalisation is, however, unlikely. Freer trade is a public good which requires international collective action to be provided. Countries which have a clear-cut trade interest in liberalising markets for commodities they export can play the role of catalyst in international co-ordination. The existence of big players is a favourable factor. Hence, the drift of the Round towards a co-ordination of US-EC interests. Both political economy and trade interest considerations suggest that an agreement reached will have its main impact on crops which are widely traded. The main constraining factor of an agreement on EC and US agriculture will be the discipline it will impose on the use of export subsidies. Agriculture will still not come fully under GATT rules which apply to other sectors, but in the future the CAP will be more constrained by international commitments than in the past.     

Stochastic duration and fast coupon bond option pricing in multi-factor models

Generalizing Cox, Ingersoll, and Ross (1979), this paper defines the stochastic duration of a bond in a general multi-factor diffusion model as the time to maturity of the zero-coupon bond with the same relative volatility as the bond. Important general properties of the stochastic duration measure are derived analytically, and the stochastic duration is studied in detail in various well-known models. It is also demonstrated by analytical arguments and numerical examples that the price of a European option on a coupon bond (and, hence, of a European swaption) can be approximated very accurately by a multiple of the price of a European option on a zero-coupon bond with a time to maturity equal to the stochastic duration of the coupon bond. This revised version was published online in June 2006 with corrections to the Cover Date.     

Social class, family background, and intergenerational mobility

This research examines the various approaches taken by economists and sociologists for analyzing intergenerational mobility. Social mobility models based on social classes arising from an occupational classification scheme are analysed. A test for the statistical validity of classification schemes is proposed and tested using Danish sample survey data that was first collected in 1976 and augmented in 2000. This is referred to as a homogeneity test and is a likelihood ratio test of a set of linear restrictions which define social classes. For Denmark it is shown that this test fails for an Erikson-Goldthorpe classification system, raising doubts about the statistical validity of occupational classification systems in general. We also estimate regression models of occupational earnings, household earnings, and educational attainment using family background variables as covariates controlling for unobservables, measurement error, and simultaneous equation bias. In these models homogeneity tests are also rejected. We conclude from these results that the individual's family background has a small but significant impact on lifetime chances which is not captured by the Erikson-Goldthorpe classification scheme.     

Equilibrium in securities markets with heterogeneous investors and unspanned income risk

In a finite time horizon, incomplete market, continuous-time setting with dividends and investor incomes governed by arithmetic Brownian motions, we derive closed-form solutions for the equilibrium risk-free rate and stock price for an economy with finitely many heterogeneous CARA investors and unspanned income risk. In equilibrium, the Sharpe ratio is the same as in an otherwise identical complete market economy, whereas the risk-free rate is lower and, consequently, the stock price is higher. The reduction in the risk-free rate is highest when the more risk-averse investors face the largest unspanned income risk.     

Dynamic asset allocation with stochastic income and interest rates

We solve for optimal portfolios when interest rates and labor income are stochastic with the expected income growth being affine in the short-term interest rate in order to encompass business cycle variations in wages. Our calibration based on the Panel Study of Income Dynamics (PSID) data supports this relation with substantial variation across individuals in the slope of this affine function. The slope is crucial for the valuation and riskiness of human capital and for the optimal stock/bond/cash allocation both in an unconstrained complete market and in an incomplete market with liquidity and short-sales constraints.     

Tax-tariff reform with costs of tax administration

As is broadly recognised, the straightforward application of the Diamond–Mirrlees (1971) production efficiency theorem implies that when lump-sum taxation is not available, then it is optimal for the government in a small open economy to rely on taxes on the net demand of households rather than on border taxes to finance its resource requirements. However, the theorem does not hold when taxation is associated with administrative costs. The present paper explores the implications for optimal taxation and for desirable directions of tax-tariff reform of taking into account the costs of tax administration in countries at different levels of economic development. The paper clarifies the reasons for, and lends support to, the criticism by Stiglitz (Presentation to Congress of International Institute of Public Finance, Prague, 2003) of the IMF and the World Bank’s recommendation to developing countries to adopt VAT to replace border taxes.