nep-mic New Economics Papers
on Microeconomics
Issue of 2011‒01‒03
twenty-one papers chosen by
Vaishnavi Srivathsan
Indian Institute of Technology

  1. Competitive equilibrium with search frictions: Arrow-Debreu meets Diamond-Mortensen-Pisarides By Belén Jerez
  2. Exclusive contracts in health insurance By Rahkovsky, Ilya
  3. Altruistic Behavior and Correlated Equilibrium Selection By Giuseppe De Marco; Jacqueline Morgan
  4. Inter-firm rivalry and firm growth: Is there any evidence of direct competition between firms? By Alex Coad; Mercedes Teruel
  5. Provider Incentives and Delivery of Developmental Goods By Mishra, Ajit; Sarangi, S.
  6. Do all-equity firms destroy value by holding cash? By Kisser, Michael
  7. The tri-party repo market before the 2010 reforms By Adam Copeland; Antoine Martin; Michael Walker
  8. Ethnic Minorities in the European Union: An Overview By Martin Kahanec; Anzelika Zaiceva; Klaus F. Zimmermann
  9. On the Use of Policy Iteration as an Easy Way of Pricing American Options By Jan Hendrik Witte; Christoph Reisinger
  10. The effect of education on migration: Evidence from school reform By Böckerman, Petri; Haapanen, Mika
  11. Smoking, Expectations, and Health: A Dynamic Stochastic Model of Lifetime Smoking Behavior By Darden, M
  12. Local Electoral Incentives and Decentralized Program Performance By de Janvry, Alain; Finan, Frederico S; Sadoulet, Elisabeth
  13. Optimal taxation and monitoring in an economy with matching frictions and underground activities By Lisi, Gaetano
  14. Convergence Patterns in Financial Development: Evidence from Club Convergence By Nicholas Apergis; Christina Christou; Stephen M. Miller
  15. Labor Market Effects of Trade and FDI: Recent Advances and Research Gaps By Pflüger, Michael P.; Blien, Uwe; Möller, Joachim; Moritz, Michael
  16. Wealth Dynamics and a Bias Toward Momentum Trading By Blake LeBaron
  17. Economic Theory and Banking Regulation: The Italian Case (1861-1930s) By Alfredo Gigliobianco; Claire Giordano
  18. Transfer pricing rules, OECD guidelines, and market distortions By Kristian Behrens; Susana Peralta; Pierre M. Picard
  19. Eliciting Beliefs: Proper Scoring Rules, Incentives, Stakes and Hedging By Armantier, Olivier; Treich, Nicolas
  20. Ownership Structure and Productivity of Vertical Research Collaboration By NAGAOKA Sadao
  21. Discrimination in the Equilibrium Search Model with Wage-Tenure Contracts By Fang, Zheng; Sakellariou, Chris

  1. By: Belén Jerez
    Abstract: When the trading process is characterized by search frictions, traders may be rationed so markets need not clear. We argue that rationing can be part of general equilibrium, even if it is outside its normal interpretation. We build a general equilibrium model where the uncertainty arising from rationing is incorporated in the definition of a commodity, in the spirit of the Arrow- Debreu theory. Prices of commodities then depend not only on their physical characteristics, but also on the probability that their trade is rationed. The standard definition of a competitive equilibrium is extended by replacing market clearing with a matching condition. This condition relates the traders' rationing probabilities to the measures of buyers and sellers in the market via an exogenous matching function, as in the search models of Diamond (1982a, 1982b), Mortensen (1982a, 1982b) and Pissarides (1984, 1985). When search frictions vanish (so matching is frictionless) our model is equivalent to the competitive assignment model of Gretsky, Ostroy and Zame (1992, 1999). We adopt their linear programming approach to derive the welfare and existence theorems in our environment.
    Keywords: Search frictions, Competitive (price-taking) equilibrium, Matching function, Linear programming, Duality
    JEL: D50 D61 D80
    Date: 2010–12
  2. By: Rahkovsky, Ilya
    Abstract: Competition between insurance companies for employees of a firm often increases the prices and reduces the availability of high-quality health plans offered to employees. An insurance company can reduce competition by signing an exclusive contract, which guarantees that the company is the only insurance provider. The study assesses whether exclusive contracts can alleviate the negative consequences of competition. Using the nation-wide survey of employers, I find that exclusive insurers charged 39-42 less for a unit of insurance quality than non-exclusive insurers. Furthermore, I find that the pattern of insurance quality dispersion is consistent with the exclusive insurers offering more high quality plans.
    Keywords: health insurance; exclusive contract; subsidy; vertical restraint; signaling
    JEL: I11 D86 G22 L42 J32
    Date: 2010–12–15
  3. By: Giuseppe De Marco (Università di Napoli Parthenope); Jacqueline Morgan (Università di Napoli Federico II and CSEf)
    Abstract: This paper studies new refinement concepts for correlated equilibria based on altruistic behavior of the players and which generalize some refinement concepts introduced by the authors in previous papers for Nash equilibria. Effectiveness of the concepts, relations with the corresponding notions for Nash equilibria and with other correlated equilibrium refinements are investigated. The analysis of the topological properties of the set of solutions concludes the paper.
    Keywords: correlated equilibrium, altruistic behavior, refinement
    Date: 2010–12–13
  4. By: Alex Coad; Mercedes Teruel
    Abstract: Inter-firm competition has received much attention in the theoretical literature, but recent empirical work suggests that the growth rates of rival firms are uncorrelated, and that firm growth can be taken as an essentially independent process. We begin by investigating the correlations of the growth rates of competing firms (i.e. the largest and second-largest firms in the same industry) and observe that, surprisingly, the growth of these firms can be taken as independent. Nevertheless, peer-effect regressions, that take into account the simultaneous interdependence of growth rates of rival firms, are able to identify significant negative effects of rivals' growth on a firm's growth.
    Keywords: Competition, Firm growth, Peer effects econometrics Length 32 pages
    JEL: L25
    Date: 2010–12
  5. By: Mishra, Ajit; Sarangi, S.
    Abstract: We use a donor-provider-agent framework to study the delivery of de- velopmental goods (i.e. aid, credit, technology transfer to poor). The need to provide incentives for the intermediate provider has been a key issue in the recent academic as well as non-academic discourses. We show that the use of high-powered incentives can lead to breadkdown of communications between the provider and the agents. We study the interplay between incen- tives and communication failure in the presence of motivated providers who derive bene…ts from helping the disadvantaged.
    Keywords: incentives; communication; motivated provider; developmental goods
    Date: 2010–12
  6. By: Kisser, Michael (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)
    Abstract: Empirical evidence shows that as of 2006, nearly every fifth large U.S. public corporation was all-equity financed and that the corresponding average cash holding were nearly twice as high as of the average U.S. firm. This paper therefore presents a simple real-options model to characterize the value of cash for all-equity financed firms and analyze its impact on a firm's investment decision. The model shows that precautionary saving may lead to a delay in investment policy compared to the benchmark of full external financing. This is because saving is an option to invest at a lower price in the future and this option has an additional time value, thereby delaying optimal investment. In the context of growth options and external financing frictions cash has extra value but this value is mostly negatively related to volatility. Testing empirically whether all-equity firms destroy value by holding that much cash, I show that on average the market values cash approximately at par. Moreover, cash is rather valued at a premium if the presence of growth opportunities is being controlled for.
    Keywords: All-equity firms; cash holding
    JEL: G00
    Date: 2010–12–21
  7. By: Adam Copeland; Antoine Martin; Michael Walker
    Abstract: This paper provides a descriptive and quantitative account of the tri-party repo market before the reforms proposed in 2010 by the Task Force on Tri-Party Repo Infrastructure (Task Force 2010). We provide an extensive description of the mechanics of this market. We also use data from July 2008 to early 2010 to document quantitative features of the market. We find that both the level of haircuts and the amount of funding were surprisingly stable in this market. The stability of the margins is in contrast to evidence from other repo markets. Perhaps surprisingly, the data reveal relatively few signs of stress in the market for dealers other than Lehman Brothers, on which we provide some evidence. This suggests that runs in the tri-party repo market may occur precipitously, like traditional bank runs, rather than manifest themselves as large increases in margins.
    Keywords: Repurchase agreements ; Law and legislation
    Date: 2010
  8. By: Martin Kahanec; Anzelika Zaiceva; Klaus F. Zimmermann
    Abstract: This paper sheds light on the labor market situation of ethnic minorities in the European Union. Facing a serious measurement challenge and lacking adequate data, we apply several measures of ethnicity and examine various data sources as well as secondary evidence. We find significant gaps between ethnic minority and majority populations in terms of labor market outcomes. In particular, ethnic minorities appear to face disproportional difficulties in finding a job. Although experience in the host country improves the status of immigrant minorities, we do not find any clear assimilation of further immigrant generations. Roma people seem to face particularly grave integration barriers in European labor markets.
    Keywords: ethnicity, ethnic minority, migration, unemployment, labor force participation, labor market
    JEL: F22 J15 J61 J71
    Date: 2010
  9. By: Jan Hendrik Witte; Christoph Reisinger
    Abstract: When using finite differences or finite elements for American option pricing, one usually has to solve what is known as a discrete linear complementarity problem (LCP). Widely used methods for solving this discrete LCP include projected successive over-relaxation (PSOR) (cf. [Cryer, 1971]) and penalty approximation (cf. [Forsyth & Vetzal, 2002]). In this paper, we demonstrate that policy iteration, introduced in the context of HJB equations in [Forsyth & Labahn, 2007], is another extremely simple and highly competitive algorithm for solving the American option LCP.
    Date: 2010–12
  10. By: Böckerman, Petri; Haapanen, Mika
    Abstract: A polytechnic, higher education reform took place in Finland in the 1990s. It gradually transformed former vocational colleges into polytechnics and expanded higher education to all Finnish regions. We implement instrumental variables estimators that exploit the exogenous variation in the regional availability of polytechnic education together with matriculation exam scores. Our IV results show that polytechnic graduates have a higher migration probability than those of vocational college graduates. However, a master’s degree did not increase migration propensity in comparison with a polytechnic degree. We also find that an increase in the availability of polytechnic education did not reduce migration.
    Keywords: Migration; higher education; polytechnic reform; IV estimation
    JEL: I20 J10 J61 R23
    Date: 2010–12–21
  11. By: Darden, M
    Abstract: This research discusses results obtained through formulation and estimation of a dynamic stochastic model that captures individual smoking decision making, health expectations, and longevity over the life cycle. The standard rational addiction model is augmented with a Bayesian learning process about the health marker transition technology to evaluate the importance of personalized health information in the decision to smoke cigarettes. Additionally, the model is well positioned to assess how smoking, and smoking cessation, impacts morbidity and mortality outcomes while taking into consideration the potential for dynamic selection of smoking behaviors. This research also provides a novel approach to the empirical construction of the theoretically common “smoking stock” that facilitates the estimation of investment and depreciation parameters. The structural parameters are estimated using rich longitudinal health and smoking data from the Framingham Heart Survey: Offspring Cohort. Results suggest that there exists heterogeneity across individuals in the pathways by which smoking effects health. Furthermore, upon smoking, the estimated parameters suggest a positive reinforcement effect and a negative withdrawal effect, both of which encourage future smoking. The paper also presents evidence of health selection in smoking behavior that, when not modeled, may cause an overstatement of the effect of smoking on morbidity and mortality. Finally, personalized health marker information is not found to significantly influence smoking behavior relative to chronic health shocks themselves.
    Date: 2010–10
  12. By: de Janvry, Alain (University of California, Berkeley); Finan, Frederico S (University of California, Berkeley); Sadoulet, Elisabeth (University of California, Berkeley)
    Abstract: This paper analyzes how electoral incentives affected the performance of a major decentralized conditional cash transfer program intended on reducing school dropout rates among children of poor households in Brazil. We show that while this federal program successfully reduced school dropout by 8 percentage points, the program's impact was 36 percent larger in municipalities governed by mayors who faced reelection possibilities compared to those with lame-duck mayors. First term mayors with good program performance were much more likely to get re-elected. These mayors adopted program implementation practices that were not only more transparent but also associated with better program outcomes.
    Keywords: decentralization, electoral incentives, conditional cash transfer, impact evaluation
    JEL: D78 H43 I28 O15
    Date: 2010–12
  13. By: Lisi, Gaetano
    Abstract: This short paper shows the interdependence of taxation and monitoring policy in a search and matching model of equilibrium unemployment with an underground sector. More precisely, from a social welfare standpoint, two options are available to the policy maker: s/he may either substitute a tighter monitoring with a higher penalty or enforce both a higher taxation and an increased monitoring.
    Keywords: optimal taxation; tax evasion; underground economy; job search theory
    JEL: H21 J64 E26 H26
    Date: 2010–11–27
  14. By: Nicholas Apergis (University of Piraeus); Christina Christou (University of Piraeus); Stephen M. Miller (University of Connecticut and University of Nevada, Las Vegas)
    Abstract: This paper analyzes the degree of convergence of financial development for a panel of 50 countries. We apply the methodology of Phillips and Sul (2007) to various financial development indicators to assess the existence of convergence clubs. We consider nine such indicators that various researchers use to proxy for the degree of financial development in countries. Overall, the results do not support the hypothesis that all countries converge to a single equilibrium state in financial development. Nevertheless, strong evidence exists of club convergence. Countries demonstrate a high degree of convergence in the sense that they form only two or three converging clubs, depending on the measure of financial development used. We then apply the Phillip-Sul method to per capita output and also find strong evidence of seven distinct convergence clubs in per capita output. Finally, we compare the various convergence clubs associated with financial development indicators to those clubs for per capita output. We conclude that strong evidence supports the correspondence between the convergence clubs for financial development and those for per capita output.
    Keywords: economic growth, financial development, convergence clustering approach, financial indicators
    JEL: F43 F32 G21 C33
    Date: 2010–12
  15. By: Pflüger, Michael P. (University of Passau); Blien, Uwe (IAB, Nürnberg); Möller, Joachim (IAB, Nürnberg); Moritz, Michael (IAB, Nürnberg)
    Abstract: This paper pursues three aims. First, we provide a review of current theoretical advances which pertain to the relationship between trade, FDI and labor markets. We do so under the following (not mutually exclusive) headings: (1) slicing-up the value added chain and the turn to a task-based approach, (2) firm heterogeneity and labor markets, (3) complex offshoring (integration) and sourcing strategies and (4) location of firms and labor markets. Second, we overview existing empirical work covering the labor market effects of trade and FDI. Finally, we identify and summarize the existing research gaps and thereby we highlight promising avenues for future research.
    Keywords: offshoring, outsourcing, FDI, trade, labor markets, agglomeration
    JEL: F16 F23 R12 J60
    Date: 2010–12
  16. By: Blake LeBaron (International Business School, Brandeis University)
    Abstract: Evolutionary metaphors have been prominent in both economics and finance. They are often used as basic foundations for rational behavior and efficient markets. Theoretically, a mechanism which selects for rational investors actually requires many caveats, and is far from generic. This paper tests wealth based evolution in a simple, stylized agent-based financial market. The setup borrows extensively from current research in finance that considers optimal behavior with some amount of return predictability. The results confirm that with a homogeneous world of log utility investors wealth will converge onto optimal adaptive forecasting parameters. However, in the case of utility functions which differ from log, wealth selection alone converges to parameters which are economically far from the optimal forecast parameters. This serves as a strong reminder that wealth selection and utility maximization are not the same thing. Therefore, suboptimal financial forecasting strategies may be difficult to drive out of a market, and may even do quite well for some time.
    Date: 2010–12
  17. By: Alfredo Gigliobianco (Bank of Italy, Structural Economic Analysis Department); Claire Giordano (Bank of Italy, Structural Economic Analysis Department)
    Abstract: The paper provides a qualitative assessment of the role mainstream economic theory had in orienting Italy’s banking legislation from its political unification (1861) to the introduction of the 1936 Banking Act. Five regulatory regimes are considered. Whilst market discipline and self-regulation arguments characterized the first sub-period (1861-1892), the debate over convertibility and limits on note issuance was intense in the second (1893-1906). The third sub-period (1907-1925) was punctuated by two banking crises: the first (1907) vindicated economists who had stressed the need of a lender of last resort à la Bagehot; the second (1921-23) confirmed – to no avail – the dangers congenital to bank-industry ties. The following sub-period (1926-1930) was inaugurated by the first commercial bank regulation (1926) and responded to the prevailing economists’ call for restricting bank competition. The 1936 regulation, which inaugurated the approximately five-decade long fifth regime, matured in a virtual vacuum of professional economic debate. Overall, two key factors were found to affect the degree to which legislation drew upon contemporary economic thought: a) the severity of the preceding crisis; and b) the timing of the subsequent regulation.
    Keywords: banking crises, prudential regulation, economic theory
    JEL: B15 G28 N4
    Date: 2010–11
  18. By: Kristian Behrens (Université du Québec à Montréal (UQAM), Canada; CORE, Université catholique de Louvain, Belgium; CIRPÉE, Canada; and CEPR, London); Susana Peralta (Universidade Nova de Lisboa, Portugal; CORE, Université catholique de Louvain, Belgium, and CEPR); Pierre M. Picard (CREA, Université du Luxembourg, Luxembourg; and CORE, Université catholique de Louvain, Belgium)
    Abstract: We study the impact of transfer pricing rules on sales prices, firms' organizational structure, and consumers' utility within a two-country monopolistic competition model featuring source-based profit taxes that differ across countries. Firms can either become multinationals, i.e., they serve the foreign market through a fully controlled a¢ liate; or they can become exporters, i.e., they serve the foreign market by contracting with an independent distributor. Compared to the benchmark cases, where tax authorities are either unable to audit firms or where they are able to audit them perfectly, the use of the OECD's Comparable Uncontrolled Price (CUP) or Cost-Plus (CP) rule distorts firms' output and pricing decisions. The reason is that the comparable arm's length transactions between exporters and distributors, which serve as benchmarks, are not efficient. We show that implementing the CUP or CP rules is detrimental to consumers in the low tax country, yet benefits consumers in the high tax country.
    Keywords: transfer pricing; OECD guidelines; multinationals and exporters; organizational choice; arm's length principle
    JEL: F12 H25 H26 H87 L14
    Date: 2010
  19. By: Armantier, Olivier; Treich, Nicolas
    Date: 2010–12
  20. By: NAGAOKA Sadao
    Abstract: This paper analyzes empirically how significantly the existence of non-contractible research effort by a vertical partner (as measured by a provision of a co-inventor) affects the ownership structure of vertical collaborative research and whether such effort also significantly enhances research productivity, exploiting rich information at the project level provided by a large scale inventor survey in Japan. Participation of a supplier co-inventor significantly enhances research productivity and is also a very significant determinant of the ownership structure, controlling for the initial knowledge contribution and the financial contribution by a supplier. On the other hand, while a user co-inventor affects the ownership structure even more predominantly, it contributes much less to the productivity of joint research. Such a gap may be partly explained by the necessity of a user to combine relevant patents. Finally, the willingness to license is not lower for a vertically co-owned patent, even if co-ownership partly substitutes a license. This suggests that co-ownership does not significantly constrain licensing, even if ex-post agreement for a license becomes necessary.
    Date: 2010–12
  21. By: Fang, Zheng; Sakellariou, Chris
    Abstract: We extend the Burdett and Coles (2003) search model with wage-tenure contracts to two types of workers and firms and derive the equilibrium earnings distributions for both types of workers, by means of which we succeed in predicting many stylized facts found in empirics. For example, we find that at the same wage level, majority workers almost always experience a faster wage increase than the minority workers; minority workers have a higher unemployment rate; discriminating firms make lower profit than non-discriminating firms and offers to minority workers by non-discriminating firms are consistently superior to those provided by discriminating firms etc. Besides, we find a similar result to the classical discrimination theory that the average wage of the majority workers, though higher in most cases, can be smaller than their counterpart’s wage when the fraction of discriminating firms is small and the degree of recruiting discrimination and disutility are mild. We also show that in a special case of CRRA utility function with the coefficient of relative risk aversion approaching infinity, our model degenerates to Bowlus and Eckstein (2002).
    Keywords: discrimination; wage gap; equilibrium search; wage-tenure
    JEL: J41 J31 J71
    Date: 2010–02

This nep-mic issue is ©2011 by Vaishnavi Srivathsan. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.