On the Market for Venture Capital
Boyan Jovanovic and and Bálazs Szentes
We propose a theory of the market for venture capital that links the excess return to venture equity to the scarcity of venture capitalists (VC’s). High returns make the VCs more selective and eager to terminate non-performing ventures because they can move on to new ones. The scarcity of VC’s enables them to internalize their social value, and the competitive equilibrium is socially optimal. Moreover, the bilaterally efficient contract is a simple equity contract. We estimate the model for the period 1989-2001 and compute the excess return to venture capital, which turns out to be 8.6%. Finally, we back out the return of solo entrepreneurs which, regardless of their wealth, is always below that of a VC.
Pass-Through as an Economic Tool: Principles of Incidence under Imperfect Competition
E. Glen Weyl and Michal Fabinger
We extend five principles of tax incidence under perfect competition to a general model of imperfect competition. The principles cover 1) the independence of physical and economic incidence, the 2) qualitative and 3) quantitative manner in which taxes are split between consumers and producers, 4) the determinants of tax pass-through and 5) the integration of local incidence to determine the overall division of surplus. We show how these principles can be used to simplify and generalize the analysis of a range of economic questions such as the optimal procurement of new markets and the welfare effects of third-degree price discrimination.
Yukio Koriyama, Jean-François Laslier, Antonin Macé, and Rafael Treibich
This paper provides a theoretical foundation which supports the degressive proportionality principle in apportionment problems, such as the allocation of seats in a federal parliament. The utility assigned by an individual to a constitutional rule is a function of the frequency with which each collective decision matches the individual's own will. The core of the argument is that, if the function is concave, then classical utilitarianism at the social level recommends decision rules which exhibit degressive proportionality with respect to the population size.
Deconstructing Lifecycle Expenditure
Mark Aguiar and Erik Hurst
In this paper we revisit two well-known facts regarding lifecycle expenditures. The first is the familiar “hump" shaped lifecycle profile of nondurable expenditures. The second is that cross-household consumption inequality increases steadily throughout the lifecycle. We document that the behavior of total nondurables masks surprising heterogeneity in the lifecycle profile of individual consumption sub-components. We provide evidence that the categories driving lifecycle consumption are either inputs into market work (clothing and transportation) or are amenable to home production (food). Using a quantitative model, we document that the disaggregated lifecycle consumption profiles imply a level of uninsurable permanent income risk that is similar to that implied by wage data and substantially lower than that implied by a model using only a composite consumption good.
The Origins of Inequality: Insiders, Outsiders, Elites, and Commoners
Gregory K. Dow and Clyde G. Reed
Hereditary economic inequality is unknown among mobile foragers, but hereditary class distinctions between elites and commoners exist in some sedentary foraging societies. With agriculture, such stratification tends to become more pronounced. We develop a model to explain the associations among productivity, population, property rights, and inequality. Using Malthusian dynamics, we show that regional productivity growth leads to enclosure of the best sites first, creating inequality between insiders and outsiders. Hereditary elite and commoner classes subsequently arise at the best sites. Food consumption becomes more unequal and commoners become poorer. These predictions are consistent with a wide range of archaeological evidence.
Roland G. Fryer and Glenn C. Loury
Diversity-enhancing policies are practiced around the world. This paper explores the economics of such policies. A model is proposed where heterogeneous agents, distinguished by skill level and social identity, purchase productive opportunities (or slots) in a competitive market. The problem of designing an efficient policy to raise the status of a disadvantaged identity group in this competition is considered. We show that: (i) when agent identity is fully visible and contractible, efficient policy grants preferred access to slots, but offers no direct assistance for acquiring skills; and, (ii) when identity is not contractible, efficient policy provides universal subsidies to skill development when the fraction of the disadvantaged group at the skill development margin is larger than their share at the slot assignment margin.
Smooth Ambiguity Aversion Toward Small Risks and Continuous-Time Recursive Utility
Assuming Brownian/Poisson uncertainty, a certainty equivalent (CE) based on the smooth second-order expected utility of Klibanoff, Marinacci, and Mukerji (Econometrica, 2005) is shown to be approximately equal to an expected-utility CE. As a consequence, the corresponding continuous-time recursive utility form is the same as for Kreps-Porteus utility. The analogous conclusions are drawn for a smooth divergence CE, based on a formulation of Maccheroni, Marinacci, and Rustichini (Econometrica, 2006), but only under Brownian uncertainty. Under
Poisson uncertainty, a smooth divergence CE can be approximated with an expected-utility CE if and only if it is of the entropic type. A non-entropic divergence CE results in a new class of continuous-time recursive utilities that price Brownian and Poissonian risks differently.
Toward an Understanding of Learning by Doing: Evidence from an Automobile Assembly Plant
Steven D. Levitt, John A. List, and Chad Syverson
We use detailed data from an assembly plant of a major auto producer to investigate the learning by doing process. We focus on the acquisition, aggregation, transmission, and embodiment of the knowledge stock built through learning. We find that most of the substantial learning by doing knowledge at the plant was not retained by the plant’s workers, even though they were an important conduit for knowledge acquisition. This finding is consistent with the plant’s institutionalized systems for productivity measurement and improvement. We further explore how overall learning is undergirded by what happens at the hundreds of individual processes along the production line. Our results shed light not only on how productivity gains accrue at the plant level, but also how firms apply managerial inputs to expand production.
What Ties Return Volatilities to Price Valuations and Fundamentals?
Alexander David and Pietro Veronesi
Stock and Treasury bond comovement, volatilities, and their relations to their price valuations and fundamentals change stochastically over time, both in magnitude and direction. These stochastic changes are explained by a general equilibrium model in which agents learn about composite economic and inflation regimes. We estimate our model using both fundamentals and asset prices, and find that inflation news signals either positive or negative future real economic growth depending on the times, thereby affecting the direction of stock/bond comovement. The learning dynamics generate strong non-linearities between volatilities and price valuations. We find empirical support for numerous predictions of the model.
The International Diversification Puzzle Is Not as Bad as You Think
Jonathan Heathcote and Fabrizio Perri
In one-good international macro models with nondiversifiable labor income risk, country portfolios are heavily biased toward foreign assets. The fact that the opposite pattern of diversification is observed empirically constitutes the international diversification puzzle. This paper embeds a portfolio choice decision in a two-country, two-good version of the stochastic growth model. In this environment, which is a workhorse for international business cycle research, equilibrium country portfolios can be characterized in closed form. Portfolios are biased toward domestic assets, as in the data. Home bias arises because endogenous international relative price fluctuations make domestic assets a good hedge against labor income risk. Evidence from developed economies in recent years is qualitatively and quantitatively consistent with the mechanisms highlighted by the theory.
Disease and Development Revisited
David E. Bloom, David Canning, and Günther Fink
Acemoglu and Johnson (2007) present evidence that improvements in population health do not promote economic growth. We show that their result depends critically on the assumption that initial health has no causal effect on subsequent economic growth. We argue that such an effect is likely, primarily because childhood health affects adult productivity. In our augmented model, which includes initial health, the instrumental variable proposed by Acemoglu and Johnson has no significant predictive power for improvements in health and does not identify the effect of contemporaneous improvements in health on economic growth.
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