nep-bec New Economics Papers
on Business Economics
Issue of 2005‒04‒16
twenty-one papers chosen by
Christian Calmes
Universite du Quebec en Outaouais

  1. Portfolio Diversification in Europe By Kpate ADJAOUTÉ; Jean-Pierre DANTHINE; Dušan ISAKOV
  2. Finance Matters By Pedro S. Amaral; Erwan Quintin
  3. The Macroeconomics of Delegated Management By Jean-Pierre Danthine; John B. Donaldson
  4. A Model of Dynamic Liquidity Contracts By Onur Ozgur
  5. (UBS Pensions Series 035) Asset Pricing with Limited Risk Sharing and Heterogeneous Agents By Francisco Gomes; Alex Michaelides
  6. A Toolbox for the Numerical Study of Linear Dynamic Rational Expectations Models By P. Marcelo Oviedo
  7. Direct Preference Wealth in Aggregate Household Portfolios By Pascal St-Amour
  8. Overlaying Time Scales in Financial Volatility Data By Eric Hillebrand
  9. On the Consequences of State Dependent Preferences for the Pricing of Financial Assets By Jean-Pierre Danthine; John B. Donaldson; Christos Giannikos; Hany Guirguis
  10. Mean Reversion Expectations and the 1987 Stock Market Crash: An Empirical Investigation By Eric Hillebrand
  11. Return Postage in Mail Surveys: A Meta Analysis By JS Armstrong; Edward J. Lusk
  12. Forecasting for Marketing By J. S. Armstrong; R. Brodie
  13. Aggregation of Expert Opinions By Dino Gerardi; Richard McLean; Andrew Postlewaite
  14. What Can A Service Logic Offer Marketing Theory By Christian, Grönroos
  15. After outsourcing – the outsourced unit: Dependence, capabilities and strategy By Sanner, Leif
  16. Knowledge Management: Are We Missing Something? By Paul Hildreth; Peter Wright; Chris Kimble
  17. Performance Persistence By WILLIAM N. GOETZMANN; STEPHEN J. BROWN
  18. On-the-job learning and earnings By Guillaume Destré; Louis Lévy-Garboua; Michel Sollogoub
  19. Probabilistic Patents By Michael R. Baye; John Morgan
  20. Models of Firm Dynamics and the Hazard Rate of Exits: Reconciling Theory and Evidence using Hazard Regression Models By Arnab Bhattacharjee
  21. Sticky Price Models and Durable Goods By Robert Barsky; Christopher L. House; Miles Kimball

  1. By: Kpate ADJAOUTÉ (HSBC Republic Bank (Suisse) SA & FAME); Jean-Pierre DANTHINE (HEC-University of Lausanne, CEPR & FAME); Dušan ISAKOV (HEC-University of Geneva & FAME)
    Abstract: Have the euro and accompanying measures of financial integration had a discernable impact on the degree of diversification of European investors? This is an empirical question that this paper tries to answer by exploring four alternative avenues. First we focus on the final outcome: If European investors are indeed better diversified, their consumption should be increasingly correlated. Second we check more directly what is known about the composition of Europeans’ portfolios. A third perspective focuses on the evolution of returns and prices. If indeed European investors are attempting to exploit new arbitrage opportunities opened up by the euro and European financial integration, then it is likely that these behavioral changes will be matched by significant changes in returns or in the nature of the return generating process. Finally, we explore the possibility that the answer to our question may be better revealed by examining the changes that have taken place in the investment process itself.
    Keywords: Risk sharing, Portfolio holdings, financial market integration, cross sectional dispersion
    JEL: F2 F36 G15
  2. By: Pedro S. Amaral (Southern Methodist University); Erwan Quintin (Federal Reserve Bank of Dallas)
    Abstract: We present a model in which the importance of financial intermediation for development can be measured. We generate financial differences by varying the degree to which contracts can be enforced. Economies where enforcement is poor employ less capital and less efficient technologies. Calibrated simulations reveal that both effects are important. Yet, accounting for all the observed dispersion in output requires a higher capital share or a lower elasticity of substitution between capital and labor than usually assumed. We find that the effects of changes in those technological parameters on output are markedly larger when financial frictions are present. Finance, that is, matters.
    JEL: E
    Date: 2005–02–01
  3. By: Jean-Pierre Danthine (HEC-University of Lausanne, CEPR & FAME); John B. Donaldson (Columbia University)
    Abstract: We are interested in the macroeconomic implications of the separation of ownership and control. An alternative decentralized interpretation of the stochastic growth model is proposed, one where shareholders hire a self-interested manager who is in charge of the firm’s hiring and investment decisions. Delegation is seen to give rise to a generic conflict of interests between shareholders and managers. This conflict fundamentally results from the different income base of the two types of agents, once aggregate market clearing conditions are taken into account. An optimal contract exists resulting in an observational equivalence between the delegated management economy and the standard representative agent business cycle model. The optimal contract, however, appears to be miles away from standard practice: the manager’s remuneration is tied to the firm’s total income net of investment expenses, abstracting totally from wage costs. In order to align the interest of a manager more conventionally remunerated on the basis of the firm’s operating results to those of stockholder-workers, the manager must be made nearly risk neutral. We show the limited power of convex contracts to accomplish this goal and the necessity, if the manager is too risk averse (log or higher than log), of considerably downplaying the incentive features of his remuneration. The difficulty in reconciling the viewpoints of a manager with powers of delegation and of a representative firm owner casts doubt on the descriptive validity of the macro-dynamics highlighted in the representative agent macroeconomic model.
    Keywords: business cycles, delegated management, contracting
    JEL: E32 E44
    Date: 2003–06
  4. By: Onur Ozgur (New York University)
    Abstract: The main goal of this paper is to analyze the nature of long-term liquidity contracts that arise between lenders and borrowers in the absence of perfect enforceability and when both parties are financially constrained. We study an infinite horizon dynamic contracting model between a borrower and a lender with the following features: The borrower, is credit-constrained, faces a stochastic project arrival process every period, can choose to renege each period, and can save through the lender. Projects are indivisible. The lender is resource- constrained, and can commit to the terms of the contract as long as it is ex-ante individually rational to do so. We show that: (i) Enforcement problems and endogenous resource constraints can severely curtail the possibility of financing projects, (ii) the economy exhibits investment cycles, (iii) credit is rationed if either the lender has too little capital or the borrower has too little financial collateral. This paper’s technical contribution is to show the existence and characterization of financial contracts that are solutions to a non- convex dynamic programming problem.
    Keywords: Credit Rationing, Investment Cycles, Limited Enforceability, Liquidity Provision, Resource Constraints
    JEL: C6 C7 D9 G2
    Date: 2005–02–15
  5. By: Francisco Gomes; Alex Michaelides
    Abstract: We solve a model with incomplete markets and heterogeneous agents that generates a large equity premium, while simultaneously matching stock market participation and individual asset holdings. The high risk premium is driven by incomplete risk sharing among stockholders, which results from the combination of borrowing constraints and (realistically) calibrated life-cycle earnings profiles, subject to both aggregate and idiosyncratic shocks. We show that it is challenging to simultaneously match aggregate quantities (asset prices) and individual quantities (asset allocations). Furthermore, limited participation has a negligible impact on the risk premium, contrary to the results of models where it is imposed exogenously.
    Date: 2005–04
  6. By: P. Marcelo Oviedo (Iowa State University)
    Abstract: By simplifying the computational tasks and by providing step-by-step explanations of the procedures required to study a linear dynamic rational expectations (LDRE) model, this paper and the accompanying ``LDRE Toolbox' of Matalb functions guide a researcher with almost no experience in computational work to resolve and study his own model. After coding the model following specific guidelines, a single function call is all that is needed to log-linearize the model; simulate it under exogenous sequences of shocks; compute sample and population moment conditions; and obtain impulse-response functions. Three classical models in the Real-Business-Cycles literature are solved and studied throughout to give detailed examples of the steps involved in solving and studying LDRE models using the LDRE Toolbox. Namely, the economies in Brock and Mirman (Optimal Growth and Uncertainty: the Discounted Case, Journal of Economic Theory, 4(3): 479-513; 1972); King, Plosser, and Rebelo (Production, Growth and Business Cycles I: The Basic Neoclassical Model, Journal of Monetary Economics 21: 195-232; 1988); and Mendoza (Real Business Cycles in a Small Open Economy, American Economic Review 81(4): 797-818; 1991).
    Keywords: RBC models; Solution method; Toolbox of Matlab functions; Log- linear approximation techniques
    JEL: C63 C68 E32 F41
    Date: 2005–01–26
  7. By: Pascal St-Amour (Hec, University of Lausanne)
    Abstract: According to standard theory, wealth should have no intrinsic value. Yet, conventional wisdom, recent theories, and data suggest it might. We verify whether or not households have direct preferences over wealth in selecting assets. The fully structural econometric model focuses on a multivariate Brownian motion in optimal consumption, portfolios and wealth. Using aggregate portfolio data, we find that wealth (i) is directly valued, (ii) reduces marginal utility and (iii) reduces risk aversion, while we reject the HARA, and CRRA restrictions. Consequently, wealth-dependent utility generates a larger IMRS risk, justifying a larger, more predictable risk premium and a lower risk-free rate.
    Keywords: Portfolio choice; Wealth-dependent preferences; Preference for status; Asset pricing; Equity premium; Risk-free rate; Predictability
    JEL: G11 G12
    Date: 2005–03
  8. By: Eric Hillebrand (Louisiana State University, Department of Economics)
    Abstract: Apart from the well-known, high persistence of daily financial volatility data, there is also a short correlation structure that reverts to the mean in less than a month. We find this short correlation time scale in six different daily financial time series and use it to improve the short-term forecasts from GARCH models. We study different generalizations of GARCH that allow for several time scales. On our holding sample, none of the considered models can fully exploit the information contained in the short scale. Wavelet analysis shows a correlation between fluctuations on long and on short scales. Models accounting for this correlation as well as long memory models for absolute returns appear to be promising.
    Keywords: GARCH, volatility persistence, spurious high persistence, long memory, fractional integration, change-points, wavelets, time scales
    JEL: C1 C2 C3 C4 C5 C8
    Date: 2005–01–31
  9. By: Jean-Pierre Danthine (Université de Lausanne, FAME and CEPR); John B. Donaldson (Columbia University); Christos Giannikos (Baruch College, City University of New York); Hany Guirguis (Manhattan College)
    Abstract: This paper introduces state dependent utility into the standard Mehra and Prescott (1985) economy by allowing the representative agent’s coefficient of relative risk aversion to vary with the underlying economy’s growth rate. Existence of equilibrium is proved and its asymptotic properties analyzed. This generalization leads to level dependent marginal rates of substitution, a property that sharply distinguishes this model from the standard construct. For very low coefficients of relative risk aversion, the equilibrium risk free and risky security returns are demonstrated to have volatilities and an associated equity premium that substantially exceed what is found in the data. This provides a contrasting perspective on the classic “equity premium puzzle.”
    Keywords: state dependent utility; equity premium; equity premium puzzle
    JEL: D91 E21 G00 G12
    Date: 2004–06
  10. By: Eric Hillebrand (Louisiana State University, Department of Economics)
    Abstract: After the stock market crash of 1987, Fischer Black proposed a model in which he explained the crash by inconsistencies in the formation of expectations of mean reversion in stock returns. Following this explanation, a model that allows for mean reversion in stock returns is estimated on daily stock index data around the crash of 1987. The results strongly support Black’s hypothesis. Simulations show that on Friday Oct 16, 1987, a crash of 20 percent or more had a probability of more than seven percent.
    Keywords: stock-market crash, mean reversion, stock return predictability, change-points
    JEL: G10 C22
    Date: 2005–01–31
  11. By: JS Armstrong (The Wharton School); Edward J. Lusk (Social System Sciences, University of Pennsylvania)
    Abstract: This paper describes a five-step procedure for meta-analysis. Especially important was the contacting of authors of prior papers. This was done primarily to improve the accuracy of the coding; it also helped to identify unpublished research and to supply missing information. Application of the five-step procedure to the issue of return postage in mail surveys yielded significantly more papers and produced more definitive conclusions than those derived from traditional reviews. This meta-analysis indicated that business reply postage is seldom costeffective because first class postage yields an additional 9% return. Business reply rates were lower than for other first class postage in each of the 20 comparisons.
    Keywords: surveys, meta-analysis, return postage
    JEL: A
    Date: 2005–02–11
  12. By: J. S. Armstrong (The Wharton School); R. Brodie (University of Auckland)
    Abstract: Research on forecasting is extensive and includes many studies that have tested alternative methods in order to determine which ones are most effective. We review this evidence in order to provide guidelines for forecasting for marketing. The coverage includes intentions, Delphi, role playing, conjoint analysis, judgmental bootstrapping, analogies, extrapolation, rule-based forecasting, expert systems, and econometric methods. We discuss research about which methods are most appropriate to forecast market size, actions of decision makers, market share, sales, and financial outcomes. In general, there is a need for statistical methods that incorporate the manager's domain knowledge. This includes rule-based forecasting, expert systems, and econometric methods. We describe how to choose a forecasting method and provide guidelines for the effective use of forecasts including such procedures as scenarios.
    Keywords: forecasting, marketing
    JEL: A
    Date: 2005–02–04
  13. By: Dino Gerardi (Department of Economics, Yale University); Richard McLean (Department of Economics, Rutgers University); Andrew Postlewaite (Department of Economics, University of Pennsylvania)
    Abstract: Conflicts of interest arise between a decision maker and agents who have information pertinent to the problem because of differences in their preferences over outcomes. We show how the decision maker can extract the information by distorting the decisions that will be taken, and show that only slight distortions will be necessary when agents are informationally small. We further show that as the number of informed agents becomes large the necessary distortion goes to zero. We argue that the particular mechanisms analyzed are substantially less demanding informationally than those typically employed in implementation and virtual implementation. In particular, the equilibria we analyze are conditionally dominant strategy in a precise sense. Further, the mechanisms are immune to manipulation by small groups of agents.
    Keywords: Information aggregation, Asymmetric information, Cheap talk, Experts
    JEL: D7 D8
    Date: 2005–04–01
  14. By: Christian, Grönroos (Swedish School of Economics and Business Administration)
    Abstract: The goods-dominated marketing model has major shortcomings as a guiding marketing theory. Its marketing mix approach is mainly geared towards buying and does not include consumption as an integral part of marketing theory. Although it is during the process of consuming goods and services that value is generated for customers and the foundation for repeat purchasing and customer relationships are laid, this process is left outside the scope of marketing. <p> The focus in service marketing is not on a product but on interactions in service encounters. Consumption has become an integral part of a holistic marketing model. Other than standardized goods-based value propositions can be better understood when taking a servicebased approach. It is concluded that marketing based on a goods logic is but a special case of marketing based on a service logic and applicable only in certain contexts with standardized products.
    Keywords: Service marketing; marketing logic; relationship
    Date: 2005–04–05
  15. By: Sanner, Leif (Department of Business, Economics, Statistics and Informatics)
    Abstract: Outsourcing is in this study defined as the transfer of responsibility and activities, including relevant assets and resources, from a user to a legally separate party, that becomes a vendor to the user. An outsourcer transfers activities to an outsourced unit. The situation of the outsourced unit becomes problematic in its provision of goods or services to both the outsourcer and other buyers. Specifically, the outsourced unit after outsourcing has ample and tight bonds to the outsourcer and there is a need to strike a balance between dependence and independence towards the outsourcer. The investigated problem reported in this article is: How can the outsourced unit strategically handle its situation after the outsourcing? Issues at stake for the outsourced unit are: How to hand le dependence on the outsourcer. How to use and develop competitive advantages, capabilities and resources. How to develop and implement business strategy. <p> Dependence can reside in asset specificity: Relationships with the outsourcer and business partners, need for the exchange partner’s competence, joint governance systems, the relative volume of goods/services provided and/or specialization of goods/services towards the exchange partner. The structure of the market may make it more or less possible to substitute one exchange partner for another. <p> For sustainable competitive advantage, the possession of or access to strategic capabilities and resources is needed, which the outsourced unit accumulates and deploys. The firm must meet the demand with a supply based on its capabilities and resources. The outsourced unit obviously starts with resources collected and capabilities developed by the out sourcer. It is its management’s task to identify and muster the resources and strategic capabilities of the firm. Inherited capabilities and resources may thus need to be developed into capabilities that are important for the outsourcer’s new role and position. <p> In two in-depth cases outsourced units are studied with focus on dependence on the outsourcer, the units’ guiding competitive advantages, their capabilities and resources. Two distinct strategies are identified. A strategy of conjunction with the outsourcer is to make use of competitive advantages, align capabilities and resources towards the outsourcer’s needs and to build on dependence by holding specific assets of interest for the outsourcer. A strategy of disjunction implies reducing dependence on the outsourcer by seeking new alliances and markets outside the outsourcer-outsourced relation. Disharmony with either of the strategies is discussed as a reason for strategic change.
    Keywords: Outsourcing; business relations; strategy
    JEL: M10
    Date: 2005–03–16
  16. By: Paul Hildreth (University of York UK); Peter Wright (University of York UK); Chris Kimble (University of York UK)
    Abstract: As commercial organisations face up to modern pressures to downsize and outsource they have begun to realise that they have lost knowledge as people leave and take with them what they know. This knowledge is increasingly being recognised as an important resource and organisations are now taking steps to manage it. In addition, as the pressures for globalisation increase, collaboration and co-operation is becoming more distributed and international. Knowledge sharing in a distributed international environment is becoming an essential part of Knowledge Management (KM), although this area does not yet appear to be given much attention. In this paper we make a distinction between hard and soft knowledge within an organisation and argue that much of what is called KM deals with hard knowledge and emphasises capture-codify-store. This is a major weakness of the current approach to KM, equating more with Information Management than Knowledge Management. Soft knowledge is concerned more with the social and cultural aspects of knowledge, its construction and the processes through which it is sustained and shared. This paper addresses this weakness by exploring the sharing of 'soft' knowledge using the concept of communities of practice.
    Keywords: Knowledge Management, Lost Knowledge, Distributed Working, Communities of Practice
    JEL: M12 O33 O34
    Date: 2005–04–08
  17. By: WILLIAM N. GOETZMANN (Yale School of Management - International Center for Finance); STEPHEN J. BROWN (NYU Stern School of Business)
    Abstract: We explore performance persistence in mutual funds using absolute and relative benchmarks. Our sample, largely free of survivorship bias, indicates that relative risk-adjusted performance of mutual funds persists, however persistence is mostly due to funds that lag the S&P 500. A profit analysis indicates that poor performance increases the probability of disappearance. A year-by-year decomposition of the persistence effect demonstrates that the relative performance pattern depends upon the time period observed, and it is correlated across managers. Consequently, it is due to a common strategy that is not captured by standard stylistic categories, or risk adjustment procedures.
    JEL: G14
    Date: 2005–04–14
  18. By: Guillaume Destré (TEAM); Louis Lévy-Garboua (TEAM); Michel Sollogoub (TEAM)
    Abstract: A simple model of informal learning on-the-job, which combines learning by oneself and learning from others, is proposed in this paper. It yields a closed-form solution that revises Mincer-Jovanovic's (1981) treatment of tenure in the human capital earnings function by relating earnings to the individual's learning potential from jobs and firms. We estimate the structural parameters of this non-linear model on a large French survey with matched employer-employee data. We find that workers on average can learn from others ten percent of their own human capital on entering the firm, and catch half of their learning potential in just two years. The measurement of worker's learning potential in their jobs and establishments provides a simple characterization of primary-type and secondary-type jobs and establishments. We find a strong relationship between the job-specific learning potential and tenure. Predictions of dual labor market theory regarding the positive match of primary-type firms (which offer high learning opportunities) with highly endowed workers (educated, high wages) are visible at the establishment level but seem to vanish at the job's level.
    Keywords: Human capital, earnings functions, informal training, learning from others, learning by oneself, returns to tenure, dualism
    JEL: J24 J31 I2
    Date: 2005–03
  19. By: Michael R. Baye (Kelley School of Business, Indiana University); John Morgan (Haas School of Business & Department of Economics, UC Berkeley)
    Abstract: We model a homogeneous product environment where identical e-retailers endogenously engage in both brand advertising (to create loyal customers) and price advertising (to attract 'shoppers'). Our analysis allows for 'cross-channel' effects; indeed, we show that price advertising is a substitute for brand advertising. In contrast to models where loyalty is exogenous, these crosschannel effects lead to a continuum of symmetric equilibria; however, the set of equilibria converges to a unique equilibrium as the number of potential e-retailers grows arbitrarily large. Price dispersion is a key feature of all of these equilibria, including the limit equilibrium. While each firm finds it optimal to advertise its brand in an attempt to 'grow' its base of loyal customers, in equilibrium, branding (1) reduces firm profits, (2) increases prices paid by loyals and shoppers, and (3) adversely affects gatekeepers operating price comparison sites. Branding also tightens the range of prices and reduces the value of the price information provided by a comparison site. Using data from a price comparison site, we test several predictions of the model.
    Keywords: Price dispersion
    JEL: D4 D8 M3 L13
    Date: 2005–04–14
  20. By: Arnab Bhattacharjee (Department of Economics, University of St Andrews)
    Abstract: This paper considers empirical work relating to models of firm dynamics. We show that a hazard regression model for firm exits, with a modification to accommodate age-varying covariate effects, provides an empirical framework accommodating many of the features of interest in studies on firm dynamics. Modelling implications of some of the popular theoretical models are considered and a set of empirical procedures for verifying testable implications of the theoretical models are proposed. The proposed hazard regression models can accommodate negative effects of initial size that go to zero with age (active learning model), negative initial size effects that fall with age but stay permanently negative (passive learning model), conditional and unconditional hazard rates that decrease with age at higher ages, and adverse effects of macroeconomic shocks that decrease with age of the firm. The methods are illustrated using data on quoted UK firms. Consistent with the active learning model, the effect of initial size is significantly negative for a young firm and falls to zero with age. The hazard function conditional on size, other firm- and industry-level characteristics, and macroeconomic conditions decreases with age only at higher ages, but shows the weaker property of Increasing Mean Residual Life over its entire life-duration. Instability in exchange rates affects survival of very young firms strongly, and the effect decreases to insignificant levels for older firms.
    Keywords: Firm exit, Learning, Firm Dynamics, Non-proportional hazards, Hazard regression models
    JEL: C14 C34 C41 C52 D83 L16
    Date: 2005–03–29
  21. By: Robert Barsky (University of Michigan); Christopher L. House (University of Michigan); Miles Kimball (University of Michigan)
    Abstract: This paper shows that there are striking implications that stem from including durable goods in otherwise conventional sticky price models. The behavior of these models depends heavily on whether durable goods are present and whether these goods have sticky prices. If long-lived durables have sticky prices, then even small durables sectors can cause the model to behave as though most prices were sticky. Conversely, if durable goods prices are flexible then the model exhibits unwelcome behavior. Flexibly priced durables contract during periods of economic expansion. The tendency towards negative comovement is very robust and can be so strong as to dominate the aggregate behavior of the model. In an instructive limiting case, money has no effects on aggregate output even though most prices in the model are sticky.
    Keywords: Sticky prices, Durables, Comovement, Neutrality
    JEL: E21 E30 E31 E32
    Date: 2005–01–27

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