October 2015

Comment on the Campbell-Cochrane Habit Model
Lars Ljungqvist and Harald Uhlig


Campbell and Cochrane (1999) formulate a model that successfully explains a wide variety of asset pricing puzzles, by augmenting the standard power utility function with a time-varying “external habit,” that adapts nonlinearly to current and past average consumption in the economy. We demonstrate that their preference specification has the unusual implications that habit can move negatively with consumption, and that reductions in consumption can increase welfare. As a result, government interventions that occasionally destroy part of the aggregate endowment can lead to substantial welfare improvements.



The Fragile Benefits of Endowment Destruction
John Y. Campbell and John H. Cochrane


The benefits of endowment destruction documented by Ljungqvist and Uhlig (2014), and the related possibility that consumption can lower habits, are fragile. Both issues result from a particular way of discretely approximating the underlying continuous-time model, or of adapting it to jumps. Other ways of calculating the discrete-time approximation or extending the model to jumps easily overturn the results, while making no difference to the model's description of asset prices and quantities. This analysis shows how to extend models so that jumps give the same result as a jump limit of continuous movements.



Strategic Mass Killings
Joan Esteban, Massimo Morelli, and Dominic Rohner


We provide a model of conflict and mass killing decisions, to identify the key variables and situations that make mass killings more likely to occur. We predict that mass killings are most likely in countries with large amounts of natural resource rents, polarization, institutional constraints regarding rent sharing, and low productivity of labor. The role of resources like oil, gas and diamonds and other key determinants of mass killings is confirmed by our empirical results based on country level as well as ethnic group level analysis.



Entrepreneurs, Risk Aversion, and Dynamic Firms
Neus Herranz, Stefan Krasa, and Anne P. Villamil


This paper analyzes how entrepreneurs use scale, capital structure and default to manage firm risk in a dynamic, stochastic model. We show that more risk-averse entrepreneurs run smaller, more highly leveraged firms and default at a lower rate than their less risk-averse counterparts. While higher leverage as a tool for lowering risk may seem counterintuitive, running a smaller firm with higher debt reduces the amount of entrepreneur funds in the firm and better protects personal assets. We decompose optimal default into the level of ex-ante debt, the loss in personal consumption from liquidating the firm, and the entrepreneur’s ability to inject personal funds. Entrepreneurs are willing to sacrifice current consumption in the hope of future success that never materializes for the bottom 25%, but entrepreneurship is a path toward great wealth and high consumption for the top quartile.



The Double Power Law in Consumption and Implications for Testing Euler Equations
Alexis Akira Toda and Kieran Walsh


We provide evidence suggesting that the cross-sectional distributions of U.S. consumption and its growth rate obey the power law in both the upper and lower tails, with exponents approximately equal to 4. Consequently, high order moments are unlikely to exist, and the generalized method of moments estimation of Euler equations that employs cross-sectional moments may be inconsistent. Through bootstrap studies, we find that the power law appears to generate spurious non-rejection of heterogeneous-agent asset pricing models in explaining the equity premium. Dividing households into age groups, we propose an estimation approach which appears less susceptible to fat tail issues.



Political Economy in a Changing World
Daron Acemoglu, Georgy Egorov, and Konstantin Sonin


We provide a general framework for the analysis of the dynamics of institutional change (e.g., democratization, extension of political rights, or repression of different groups), and how these dynamics interact with (anticipated and unanticipated) changes in the distribution of political power and in economic structure. We focus on Markov Voting Equilibria, which require that economic and political changes should take place if there exists a subset of players with the power to implement such changes and who will obtain higher expected discounted utility by doing so. Assuming that economic and political institutions as well as individual types can be ordered, and preferences and the distribution of political power satisfy natural “single crossing” (increasing differences) conditions, we prove the existence of a pure-strategy equilibrium, provide conditions for its uniqueness, and present a number of comparative static results that apply at this level of generality. We then use this framework to study the dynamics of political rights and repression in the presence of radical groups that can stochastically grab power and the dynamics of collective experimentation over institutions.



The Medium-Term Impacts of High-Achieving Charter Schools
Will Dobbie and Roland G. Fryer, Jr.


Using survey data from the Promise Academy in the Harlem Children's Zone, collected for the purposes of this study, we estimate the effects of high-performing charter schools on human capital, risky behaviors, and health outcomes. Six years after the random admissions lottery, youth offered admission to the Promise Academy middle school score 0.279 (0.073) standard deviations higher on academic achievement outcomes, 0.067 (0.076) standard deviations higher on an index of academic attainment, and 0.313 (0.091) standard deviations higher on a measure of “on-time” benchmarks. Admitted females are 10.1 percentage points less likely to be pregnant in their teens, and males are 4.4 percentage points less likely to be incarcerated. We find little impact of the Promise Academy on self-reported health. These effects are larger than those expected from test score increases alone, implying that high achieving charter schools alter more than cognitive ability.


Climate Change Special Issue


Market-Based Emissions Regulation and Industry Dynamics
Meredith Fowlie, Mar Reguant, and Stephen Ryan


We assess the static and dynamic implications of alternative market-based policies limiting greenhouse gas emissions in the US cement industry. Our results highlight two countervailing market distortions. First, emissions regulation exacerbates distortions associated with the exercise of market power in the domestic cement market. Second, emissions “leakage” in trade exposed markets offsets domestic emissions reductions. Taken together, these forces can result in social welfare losses under policy regimes that fully internalize the emissions externality. Market-based policies that incorporate design features to mitigate the exercise of market power and emissions leakage deliver welfare gains when damages from carbon emissions are high.



Participation and Duration of Environmental Agreements
Marco Battaglini and Bard Harstad


We analyze participation in international environmental agreements (IEAs) in a dynamic game where countries pollute and invest in green technologies. If complete contracts are feasible, participants eliminate the hold-up problem associated with their investments; however, most countries prefer to free-ride rather than participate. If investments are non-contractible, countries face a hold-up problem every time they negotiate; but the free-rider problem can be mitigated and significant participation is feasible. Participation becomes attractive because only large coalitions commit to long-term agreements that circumvent the hold-up problem. Under well-specified conditions even the first-best outcome is possible when the contract is incomplete. Since real-world IEAs fit in the incomplete contracting environment, our theory may help explaining the rising importance of IEAs and how they should be designed.



Evolving Comparative Advantage and the Impact of Climate Change in Agricultural Markets: Evidence from 1.7 Million Fields around the World
Arnaud Costinot, Dave Donaldson, and Cory Smith


A large agronomic literature models the implications of climate change for a variety of crops and locations around the world. The goal of the present paper is to quantify the macro-level consequences of these micro-level shocks. Using an extremely rich micro-level dataset that contains information about the productivity—both before and after climate change—of each of 10 crops for each of 1.7 million fields covering the surface of the Earth, we find that the impact of climate change on these agricultural markets would amount to a 0.26% reduction in global GDP when trade and production patterns are allowed to adjust.



Carbon Taxes, Path Dependency and Directed Technical Change: Evidence from the Auto Industry
Philippe Aghion, Antoine Dechezleprêtre, David Hemous, Ralf Martin, and John Van Reenen


Can directed technical change be used to combat climate change? We construct new firm-level panel data on auto industry innovation distinguishing between “dirty” (internal combustion engine) and “clean” (e.g. electric and hybrid) patents across 80 countries over several decades. We show that firms tend to innovate relatively more in clean technologies when they face higher tax-inclusive fuel prices. Furthermore, there is path dependence in the type of innovation both from aggregate spillovers and from the firm's own innovation history. Using our model we simulate the increases in carbon taxes needed to allow clean technologies to overtake dirty technologies.



Transition to Clean Technology
Daron Acemoglu, Douglas Hanley, Ufuk Akcigit, and William Kerr


We develop an endogenous growth model where clean and dirty technologies compete in production. Research can be directed to either technology. If dirty technologies are more advanced, the transition to clean technology can be difficult. Carbon taxes and research subsidies may encourage production and innovation in clean technologies, though the transition will typically be slow. We estimate the model using microdata from the US energy sector. We then characterize the optimal policy path which heavily relies on both subsidies and taxes. Finally we evaluate various alternative policies. Relying only on carbon taxes or delaying intervention has significant welfare costs.



Adapting to Climate Change: The Remarkable Decline in the U.S. Temperature-Mortality Relationship over the 20th Century
Alan Barreca, Karen Clay, Olivier Deschenes, Michael Greenstone, and Joseph Shapiro


A critical part of adapting to the higher temperatures that climate change brings will be the deployment of existing technologies to new sectors and regions. This paper examines the evolution of the temperature-mortality relationship over the course of the entire 20th century in the United States both for its own interest but also to identify potentially useful adaptations that may be useful in the coming decades. There are three primary findings. First, the mortality impact of days with a mean temperature exceeding 80° F has declined by about 70%. Almost the entire decline occurred after 1960. There are about 14,000 fewer fatalities annually than if the pre-1960 impacts of high temperature on mortality still prevailed. Second, the diffusion of residential air conditioning can explain essentially the entire decline in hot day related fatalities. Third, using Dubin-McFadden’s discrete-continuous model, we estimate that the present value of US consumer surplus from the introduction of residential air conditioning (AC) in 1960 ranges from $83 to $186 billion ($2012) with a 5% discount rate. The monetized value of the mortality reductions on high temperature days due to AC accounts for a substantial fraction of these welfare gains.



Self-Control at Work
Supreet Kaur, Michael Kremer, and Sendhil Mullainathan


Workers with self-control problems do not work as hard as they would like. This changes the logic of agency theory by partly aligning the interests of the firm and worker: both now value contracts that elicit more effort in the future. Three findings from a year-long field experiment with data entry workers suggest the quantitative importance of self control at work. First, workers choose dominated contracts—which penalize low output but provide no greater reward for high output—36% of the time to motivate their future selves; use of these contracts increases output by the same amount as an 18% increase in the piece-rate. Second, effort increases as the (randomly assigned) payday gets closer: output rises 8% over the pay week; calibrations show that justifying this would require a 4% daily exponential discount rate. Third, for both findings there is significant and correlated heterogeneity: workers with larger payday effects are both more likely to choose dominated contracts and show greater output increases under them. This correlation grows with experience, consistent with the hypothesis that workers learn about their self-control problems over time. Self-control problems among workers could potentially lead firms to either adopt high-powered incentives or impose work rules to allow monitoring of worker effort.



Production vs. Revenue Efficiency with Limited Tax Capacity: Theory and Evidence from Pakistan
Michael Carlos Best, Anne Brockmeyer, Henrik Jacobsen Kleven, Johannes Spinnewijn, and Mazhar Waseem


To fight evasion, many developing countries resort to production-inefficient tax policies.
This includes minimum tax schemes whereby firms are taxed on either profits or turnover, depending on which tax liability is larger. Such schemes create non-standard kink points, which allow for eliciting evasion responses to switches between profit and turnover taxes using a bunching approach. Using administrative tax records on corporations in Pakistan, we estimate that turnover taxes reduce evasion by up to 60-70% of corporate income. Incorporating this in a calibrated optimal tax model, we find that switching from profit to turnover taxation increases revenue by 74% without reducing aggregate profits, despite the production inefficiency that it introduces.



Explaining Cross-Country Productivity Differences in Retail Trade
David Lagakos


Many macroeconomists argue that productivity is low in developing countries because of frictions that impede the adoption of modern technologies. I argue that in the retail trade sector, which employs just under twenty percent of the workforce on average, developing countries rationally choose technologies with low measured labor productivity. My theory is that the adoption of modern retail technologies is optimal only when household ownership of complementary durable goods, such as cars, is widespread. Because income is low in the developing world, households own few such durables; hence, retail trade is dominated by traditional technologies with low measured productivity. I show that an implication of this theory is that policies that lead to large increases in measured retail productivity do not necessarily lead to large increases in welfare.



Life and Growth
Charles I. Jones


Some technologies save lives—new vaccines, new surgical techniques, safer highways. Others threaten lives—pollution, nuclear accidents, global warming, and the rapid global transmission of disease. How is growth theory altered when technologies involve life and death instead of just higher consumption? This paper shows that taking life into account has first-order consequences. Under standard preferences, the value of life may rise faster than consumption, leading society to value safety over consumption growth. As a result, the optimal rate of consumption growth may be substantially lower than what is feasible, in some cases falling all the way to zero.



Those Who Know Most: Insider Trading in 18th-Century Amsterdam
Peter Koudijs


This paper studies how private information is incorporated into prices, using a unique setting from the 18th century that, in many dimensions, is simpler and closer to stylized models of price discovery than modern-day markets. Specifically, the paper looks at a number of English securities that were traded in both London and Amsterdam. Relevant information about these securities originated in London and was sent to Amsterdam on board official mail packet boats. Anecdotal evidence suggests that these ships carried both public news and private information. They sailed only twice a week, and in adverse weather could not sail at all. The paper exploits periods of exogenous market segmentation to identify the impact of private information. The evidence is consistent with a Kyle (1985) model in which informed agents trade strategically. Most important, the speed of information revelation in Amsterdam depended on how long insiders expected it would take for the private signal to become public. As a result of this strategic behavior, private information was only slowly revealed to the market as a whole. This price discovery was economically important: private signals had almost as much impact on prices as public information shocks.



Self-Targeting: Evidence from a Field Experiment in Indonesia
Vivi Alatas, Abhijit Banerjee, Rema Hanna, Benjamin A. Olken, Ririn Purnamasari, and Matthew Wai-Poi


We conduct a randomized experiment within Indonesia’s Conditional Cash Transfer program that compares two methods of targeting welfare programs: in one, beneficiaries first need to apply for the program, and then an enumerator visits them at home and determines their eligibility based on an asset test; in the other, they are visited directly by the enumerator and automatically enrolled if they qualify based on the same test. On net, the villages where applications were required have a much poorer group of beneficiaries than automatic screening villages. However, marginally increasing the cost of applying by increasing the distance to the application site does not to improve targeting. An estimated model of the decision to apply implies that our results are largely driven by the non-poor forecasting that they are unlikely to pass the asset test, and therefore not bothering to apply. The estimated model implies that the combination of the small cost and the final check yields substantially larger reductions in poverty than automatic screening, without imposing onerous ordeals on program beneficiaries.



An Endowment Effect for Risk: Experimental Tests of Stochastic Reference Points
Charles Sprenger


Recent models of reference-dependent preferences indicate that expectations may play a prominent role in the presence of behavioral anomalies. A subset of such expectations-based models predicts an “endowment effect for risk”: that risk attitudes differ when reference points change from certain to stochastic. In two purposefully simple risk preference experiments, eliminating often-discussed confounds, I demonstrate both between and within-subjects such an endowment effect for risk. These results provide needed separation between expectations based reference-dependent models, allow for evaluation of recent theoretical extensions, and may help to close a long-standing debate in decision science on inconsistency between utility elicitation methodologies.



A Measure of Rationality and Welfare
Jose Apesteguia and Miguel A. Ballester


Evidence showing that individual behavior often deviates from the classical principle of preference maximization has raised at least two important questions: (i) How serious are the deviations? and (ii) What is the best way to analyze choice behavior in order to extract information for the purpose of welfare analysis? This paper addresses these questions by proposing a new way to identify the preference relation which is closest, in terms of welfare loss, to the revealed choice.



Bonus Culture: Competitive Pay, Screening, and Multitasking
Roland Bénabou and Jean Tirole


To analyze the impact of labor market competition on the structure of compensation, we embed multitasking and screening within a Hotelling framework. Competition for talent leads to an escalation of performance pay, shifting effort away from long-term investments, risk management and cooperation. Efficiency losses can exceed those from a single principal, who dulls incentives to extract rents. As competition intensifies, monopsonistic underincentivization of low-skill agents first decreases, then gives way to growing overincentivization of high-skill ones. Aggregate welfare is thus hill-shaped, while inequality tends to rise monotonically. Bonus caps can help restore balance in incentives, but may generate other distortions.



Heterogeneity in the Production of Human Capital
Solomon W. Polachek, Tirthatanmoy Das, and Rewat Thamma-Apiroam


We derive a tractable nonlinear earnings function which we estimate separately individual-by-individual using the NLSY79 data. These estimates yield five important parameters for each individual: three ability measures (two representing the ability to learn and one the ability to earn), a rate of skill depreciation, and a time discount rate. In addition, we obtain a population wide estimate of the rental rate of human capital. To illustrate heterogeneity in the production of human capital, we plot the distribution of these parameters along with NLSY79 reported AFQT scores. By utilizing these parameters, we are able to verify a number of heretofore untested theorems relating to human capital investments. In addition, we are able to show how these human capital production function parameters relate to cognitive ability, personality traits, and family background. Further, accounting for this individual specific heterogeneity dramatically reduces estimates of population-wide persistence of (unit-root) permanent and (mean-reverting) transitory shocks.



Booms and Banking Crises
Frédéric Boissay, Fabrice Collard, and Frank Smets


Banking crises are rare events that break out in the midst of credit intensive booms and bring about particularly deep and long-lasting recessions. This paper attempts to explain these phenomena within a textbook DSGE model that features a non-trivial banking sector. In the model, banks are heterogeneous with respect to their intermediation skills, which gives rise to an interbank market. Moral hazard and asymmetric information in this market may lead to sudden interbank market freezes, banking crises, credit crunches and, ultimately, severe “financial” recessions. In our model, the typical financial recessions are very different from other types of recessions. They follow credit booms and are not triggered by an especially large negative exogenous shock. Simulations of a calibrated version of the model indicate that it can mimic the main dynamic patterns of financial recessions.



Shopping Externalities and Self-Fulfilling Unemployment Fluctuations
Greg Kaplan and Guido Menzio


We propose a novel theory of self-fulfilling unemployment fluctuations. When a firm increases its workforce, it increases the demand facing other firms—as employed workers spend more than unemployed workers—and decreases the extent of competition facing other firms—as employed workers have less time to search for low prices than unemployed workers. In turn, the increase in demand and the decline in competition induces other firms to hire more labor in order to scale-up their presence in the product market. The feedback between employment and product market conditions generates multiple equilibria—and the possibility of self-fulfilling fluctuations—if the differences in the shopping behavior of employed and unemployed workers are large enough. Empirical evidence on spending, shopping and prices paid suggests that this is the case.



Ethnic Inequality
Alberto Alesina, Stelios Michalopoulos, and Elias Papaioannou


This study explores the consequences and origins of between-ethnicity inequality for a large sample of countries. First, combining satellite images of nighttime luminosity with the homelands of ethnolinguistic groups, we construct measures of ethnic inequality. Second, we uncover a strong inverse association between ethnic inequality and contemporary development above and beyond its relationship with cross-region and cross-administrative unit inequality. Third, we establish that differences in geographic endowments across ethnic homelands explain a sizable fraction of the variation in economic disparities across groups. Fourth, we show that inequality in geographic endowments across ethnic homelands is a negative correlate of development.



Teamwork and Moral Hazard: Evidence from the Emergency Department
David C. Chan


I investigate how teamwork may reduce moral hazard by joint monitoring and management. I study two organizational systems differing in the extent to which physicians may mutually manage work: Physicians are assigned patients in a “nurse-managed” system but divide patients between themselves in a “self-managed” system. The self-managed system increases throughput productivity by reducing a “foot-dragging” moral hazard, in which physicians prolong patient stays as expected future work increases. I find evidence that physicians in the same location have better information about each other and that, in the self-managed system, they use this information to assign patients.



The Social Effects of Ethnic Diversity at the Local Level: A Natural Experiment with Exogenous Residential Allocation
Yann Algan, Camille Hémet, and David Laitin


This paper demonstrates the effects of ethnic diversity on social relationships and the quality of public goods at a very finite neighborhood level. We use detailed block level data on diversity and housing quality from a representative survey on housing in France. We show how and to what extent diversity within a neighborhood can directly affect household well-being and the quality of the common spaces, whereas the previous literature looks at more aggregate outcomes through voting channels. Our identification strategy to address the bias from endogenous residential sorting relies on the exogeneity of public housing allocations with respect to ethnic characteristics in France. Diversity is shown to have a negative effect on the quality of local public goods, either due to vandalism, not deterred by other-regarding preferences and social policing, or due to collective action failure to ensure effective property management. However, we find that diversity has no robust effect on public safety at a local level and, if anything, is more related to social anomie.



Revenue Management with Forward-Looking Buyers
Simon Board and Andrzej Skrzypacz


A seller wishes to sell multiple goods by a deadline, e.g., the end of a season. Potential buyers enter over time and can strategically time their purchases. Each period, the profit-maximizing mechanism awards units to the buyers with the highest valuations exceeding a sequence of cutoffs. We show these cutoffs are deterministic, depending only on the inventory and time remaining; in the continuous-time limit, the optimal mechanism can be implemented by posting anonymous prices. When incoming demand decreases over time, the optimal cutoffs satisfy a one-period-look-ahead property and prices are defined by an intuitive differential equation.



Selling Information
Johannes Hörner and Andrzej Skrzypacz


A Firm considers hiring an Agent who may be competent for a potential project or not. The Agent can prove her competence, but faces a hold-up problem. We propose a model of persuasion and show how gradualism helps mitigate the hold-up problem. We show when it is optimal to give away part of the information at the beginning of the bargaining, and sell the remainder in dribs and drabs. The Agent can only appropriate part of the value of information. Introducing a third-party allows her to extract the maximum surplus.



Capabilities, Wealth, and Trade
John Sutton and Daniel Trefler


This paper reexplores the relation between a country’s level of wealth and the mix of products it exports. We argue that both are simultaneously determined by countries’ capabilities, i.e., by countries’ productivity and quality levels for each good. Our theoretical setup has two features. (1) Some goods have fewer high-quality producers/countries than others, i.e., there is Ricardian comparative advantage. (2) Imperfect competition allows high- and low-quality producers to coexist, which we refer to as “product ranges.” These two features generate a very particular nonmonotonic, general equilibrium relationship between a country’s export mix and its GDP per capita. We show that this nonmonotonicity permeates the international data on trade and GDP per capita.



Gender Roles and Medical Progress
Stefania Albanesi and Claudia Olivetti


Maternal mortality was the second largest cause of death for women in childbearing years until the mid-1930s in the United States. For each death, twenty times as many mothers suffered pregnancy related conditions, which made it hard for them to engage in market work. Between 1930 and 1960 there was a remarkable improvement in maternal health. We argue that this development, by enabling women to reconcile work and motherhood, was essential for the joint rise in women’s labor force participation and fertility over this period. We also show that the diffusion of infant formula played an important auxiliary role.



Understanding Booms and Busts in Housing Markets
Craig Burnside, Martin Eichenbaum, and Sergio Rebelo


Some booms in housing prices are followed by busts. Others are not. It is generally difficult to find observable fundamentals that are useful for predicting whether a boom will turn into a bust or not. We develop a model consistent with these observations. Agents have heterogeneous expectations about long-run fundamentals but change their views because of “social dynamics.” Agents with tighter priors are more likely to convert others to their beliefs. Boom-bust episodes typically occur when skeptical agents happen to be correct. The booms that are not followed by busts typically occur when optimistic agents happen to be correct.



Labor-Market Returns to the GED Using Regression Discontinuity Analysis
Christopher Jepsen, Peter Mueser, and Kenneth Troske


We evaluate returns to General Educational Development (GED) certification for high school dropouts using state administrative data. We apply a fuzzy regression discontinuity method to account for test takers retaking the test. For women we find GED certification has no statistically significant effect on either employment or earnings. For men we find a significant increase in earnings in the second year after taking the test, but no impact in subsequent years. GED certification increases postsecondary school enrollment by four to eight percentage points. Our results differ from regression discontinuity approaches that fail to account for test retaking.



The Runner-Up Effect
Santosh Anagol and Thomas Fujiwara


Exploiting regression discontinuity designs in Brazilian, Indian, and Canadian first-past-the-post elections, we document that second-place candidates are substantially more likely than close third-place candidates to run in, and win, subsequent elections. Since both candidates lost the election and had similar electoral performance, this is the effect of being labeled the runner-up. Selection into candidacy is unlikely to explain the effect on winning subsequent elections, and we find no effect of finishing in third-place versus fourth-place. We develop a simple model of strategic coordination by voters that rationalizes the results and provides further predictions that are supported by the data.



Intermittency and the Value of Renewable Energy
Gautam Gowrisankaran, Stanley S. Reynolds, and Mario Samano


A key problem with solar energy is intermittency: solar generators only produce when the sun is shining. This adds to social costs and also requires electricity system operators to reoptimize key decisions with large-scale renewables. We develop a method to quantify the economic value of large-scale renewable energy. We estimate the model for southeastern Arizona. Not accounting for offset CO2, we find social costs of $138.4/MWh for 20% solar generation, of which unforecastable intermittency accounts for $6.1 and intermittency overall for $46. With solar installation costs of $1.52/W and CO2 social costs of $39/ton, 20% solar would be welfare neutral.



Dynamic Collective Choice with Endogenous Status Quo
Wioletta Dziuda and Antoine Loeper


We analyze a bargaining situation in which preferences evolve over time and the previous agreement becomes the next status quo. The endogeneity of the status quo exacerbates the players' conflict of interest: Players disagree more often than under exogenous status quo. This leads to inefficiencies and status quo inertia. Under certain conditions, the negotiations can come to a complete gridlock: Players never reach an agreement. Gridlock can occur between players with arbitrarily similar preferences, provided they are sufficiently patient. In legislative settings, our model predicts polarization, and explains why legislators may fail to react promptly to economic shocks.



Marriage as a Rat Race: Noisy Pre-Marital Investments with Assortative Matching
V. Bhaskar and Ed Hopkins


We study pre-marital investments in a large frictionless marriage market with nontransferable utility. We assume stochastic returns to investment, which ensures uniqueness of equilibrium. The equilibrium in our continuum agent model is the limit of the equilibria of finite models, as the number of agents tends to infinity. Equilibrium investments are utilitarian efficient when the sexes are symmetric. However, if there is any asymmetry between the sexes, investments generically exceed the Pareto-efficient level. Girls will invest more than boys if their quality shocks are less variable than those for boys, or if they are the abundant sex.



Decentralized College Admissions
Yeon-Koo Che and Youngwoo Koh


We study decentralized college admissions with uncertain student preferences. Colleges strategically admit students likely to be overlooked by competitors. Highly ranked students may receive fewer admissions or have a higher chance of receiving no admissions than those ranked below. When students' attributes are multidimensional, colleges avoid head-on competition by placing excessive weight on school-specific attributes such as essays. Restricting the number of applications or wait-listing alleviates enrollment uncertainty, but the outcomes are inefficient and unfair. A centralized matching via Gale and Shapley's deferred acceptance algorithm attains efficiency and fairness but may make some college worse off than under decentralized matching.



Debt Dilution and Sovereign Default Risk
Juan Carlos Hatchondo, Leonardo Martinez, and César Sosa-Padilla


We measure the effects of debt dilution on sovereign default risk and study debt covenants that could mitigate these effects. We calibrate a baseline model with endogenous debt duration and default risk (in which debt can be diluted) using data from Spain. We find that debt dilution accounts for 78 percent of the default risk in the baseline economy and that eliminating dilution increases the optimal duration of sovereign debt by almost two years. Eliminating dilution also increases consumption volatility, but still produces welfare gains. The debt covenants we study could help enforcing fiscal rules.



Downward Nominal Wage Rigidity, Currency Pegs, and Involuntary Unemployment
Stephanie Schmitt-Grohé and Martín Uribe


This paper analyzes the inefficiencies arising from the combination of fixed exchange rates, nominal rigidity, and free capital mobility. We document that nominal wages are downwardly rigid in emerging countries. We develop an open economy model that incorporates this friction. The model predicts that the combination of a currency peg and free capital mobility creates a negative externality that causes overborrowing during booms and high unemployment during contractions. Optimal capital controls are shown to be prudential. For plausible calibrations, they reduce unemployment by around 5 percentage points. The optimal exchange rate policy eliminates unemployment and calls for large devaluations during crises.



The Pass-Through of Sovereign Risk
Luigi Bocola


This paper examines the macroeconomic implications of sovereign credit risk in a business cycle model where banks are exposed to domestic government debt. The news of a future sovereign default hampers financial intermediation. First, it tightens the funding constraints of banks, reducing their available resources to finance firms (liquidity channel). Second, it generates a precautionary motive for banks to deleverage (risk channel). I estimate the model using Italian data, finding that i) sovereign credit risk was recessionary and that ii) the risk channel was sizable. I then use the model to evaluate the effects of subsidized long term loans to banks, calibrated to the ECB’s longer-term refinancing operations. The presence of strong precautionary motives at the time of policy enactment implies that bank lending to firms is not very sensitive to these credit market interventions.



A Supply and Demand Framework for Two-Sided Matching Markets
Eduardo M. Azevedo and Jacob D. Leshno


This paper develops a price-theoretic framework for matching markets with heterogeneous preferences. The model departs from the Gale and Shapley model by assuming that a finite number of agents on one side (colleges) are matched to a continuum of agents on the other side (students). We show that stable matchings correspond to solutions of supply and demand equations, with the selectivity of each college playing a role similar to prices. We apply the model to an analysis of how competition induced by school choice gives schools incentives to invest in quality and to asymptotics of school choice mechanisms.



Text-Based Network Industries and Endogenous Product Differentiation
Gerard Hoberg and Gordon Phillips


We study how firms differ from their competitors using new time-varying measures of product similarity based on text-based analysis of firm 10-K product descriptions. This year-by-year set of product similarity measures allows us to generate a new set of industries where firms can have their own distinct set of competitors. Our new sets of competitors explain specific discussion of high competition, rivals identified by managers as peer firms and changes to industry competitors following exogenous industry shocks. We also find evidence that
firm R&D and advertising are associated with subsequent differentiation from competitors, consistent with theories of endogenous product differentiation.



Something to Talk About: Social Spillovers in Movie Consumption
Duncan Sheppard Gilchrist and Emily Glassberg Sands


We exploit the randomness of weather and the relationship between weather and movie-going to quantify social spillovers in movie consumption. Instrumenting for early viewership with plausibly exogenous weather shocks captured in LASSO-chosen instruments, we find that shocks to opening weekend viewership are doubled over the following five weekends. Our estimated momentum arises almost exclusively at the local level, and we find no evidence that it varies with either ex-post movie quality or the precision of ex-ante information about movie quality, suggesting the observed momentum is driven in part by a preference for shared experience, and not only by social learning.



Cognitive Ability, Character Skills, and Learning to Play Equilibrium: A level-k analysis
David Gill and Victoria Prowse


In this paper we investigate how cognitive ability and character skills influence behavior, success and the evolution of play towards Nash equilibrium in repeated strategic interactions. We study behavior in a p-beauty contest experiment and find striking differences according to cognitive ability: more cognitively able subjects choose numbers closer to equilibrium, converge more frequently to equilibrium play and earn more even as behavior approaches the equilibrium prediction. To understand better how subjects with different cognitive abilities learn differently, we estimate a structural model of learning based on level-k reasoning. We find a systematic positive relationship between cognitive ability and levels; furthermore, the average level of more cognitively able subjects responds positively to the cognitive ability of their opponents, while the average level of less cognitively able subjects does not respond. Finally, we compare the influence of cognitive ability to that of character skills, and find that both cognition and personality affect behavior and learning. More agreeable and emotionally stable subjects perform better and learn faster, although the effect of cognitive ability on behavior is stronger than that of character skills.



Politicians’ Luck of the Draw: Evidence from the Spanish Christmas Lottery
Manuel Bagues and Berta Esteve-Volart


It is well known that incumbent politicians tend to receive more votes when economic conditions are good. In this paper we explore the source of this correlation, exploiting the exceptional evidence provided by the Spanish Christmas Lottery: 75% of Spaniards play this unique lottery, they share tickets, and every Christmas 0.3% of the Spanish GDP is at stake. Winners tend to be geographically clustered because several thousand tickets sharing the same winning number are typically sold by a single lottery outlet. These features allow us to study the impact of exogenous good economic conditions on voting behavior. Using electoral data, we find that incumbents receive significantly more votes in winning provinces. Survey information also shows that Christmas Lottery prizes increase support for the incumbent, but they do not affect respondents' assessment of the government or the opposition party. The evidence is consistent with a temporary increase in happiness making voters more lenient toward the incumbent, or with an increase in voter's preference for the status quo.



Why the Referential Treatment? Evidence from Field Experiments on Referrals
Amanda Pallais and Emily Glassberg Sands


Referred workers are more likely than non-referred workers to be hired, all else equal. In three field experiments in an online labor market, we examine why. We find that referrals contain positive information about worker performance and persistence that is not contained in workers' observable characteristics. We also find that referrals performed particularly well when working directly with their referrers. However, we do not find evidence that referrals exert more effort because they believe their performance will affect their relationship with their referrer or their referrer's position at the firm.



Market Transparency, Adverse Selection, and Moral Hazard
Tobias J. Klein, Christian Lambertz, and Konrad O. Stahl


We study how an improvement in market transparency affects seller exit and continuing sellers’ behavior in a market setting that involves informational asymmetries. The improvement was achieved by reducing strategic bias in buyer ratings. It led to a significant increase in buyer satisfaction with seller performance, but not to an increase in seller exit. When sellers had the choice between exiting – a reduction in adverse selection – and staying but improving behavior – a reduction in moral hazard – they preferred the latter. Increasing market transparency led to better market outcomes.



A Year of Transition: Faculty Recruiting at Chicago in 1946
David Mitch


The year 1946 has been seen as a pivotal year of transition by historians of the Chicago Economics Department, in large part due to the arrival of Milton Friedman that year. This essay examines new evidence on department deliberations on faculty hiring in February of 1946. It argues that Friedman's recruitment reflected a compromise between Frank Knight and his followers on the one hand and those associated with the Cowles Commission on the other.