NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

The NBER Reporter 2008 Number 4: Program and Working Group Meetings


China Working Group Meets in Cambridge
Entrepreneurship Working Group
Economic Fluctuations and Growth Research Meeting
Market Microstructure
Labor Studies
Political Economy
Public Economics

International Finance and Macroeconomics
Health Care
Higher Education
Education Program Meets
Monetary Economics
Asset Pricing
Behavioral Finance
Corporate Finance

China Working Group Meets in Cambridge

The NBER's Working Group on China, directed by NBER Research Associate Shang-Jin Wei of Columbia University, met on October 3 and 4 in Cambridge. These papers were presented and discussed:

Shing-Yi Wang, New York University, "Credit Constraints, Job Mobility, and Entrepreneurship: Evidence from a Property Reform in China."
Discussant: Lakshmi Iyer, Harvard University

Lena Edlund, Columbia University; Hongbin Li, Tsinghua University; and Junjian Yi and Junsen Zhang, Chinese University of Hong Kong, "Sex Ratios and Crime: Evidence from China's One-Child Policy"
Discussant: Avi Eberstein, Harvard University

Shang-Jin Wei, and Xiaobo Zhang, IFPRI, "Sex Ratio Imbalances Stimulate Savings Rates: Evidence from the 'Missing Women' in China."
Discussant: Roger H. Gordon, University of California, San Diego and NBER

Li Jin, Harvard University, and Joseph P.H. Fan and Guojian Zheng, Chinese University of Hong Kong, "Internal Capital Market in Emerging Markets: Expropriation and Mitigating Financing Constraints."
Discussant: Wei Jiang, Columbia University

Yan-Leung Cheung, City University of Hong Kong; Ping Jiang, University of International Business and Economics; and Kai Li and Tan Wang, University of British Columbia, "Privatization and Risk Sharing: Evidence from the Split Share Structure Reform in China."
Discussant: Zhiwu Chen,Yale University

Lakshmi Iyer; Xin Meng, Australian National University; and Nancy Qian, Brown University, "Property Rights and Household Decisions: The Impact of China's Urban Housing Reforms."
Discussant: Marcos Chamon, IMF

Jie Gan, Hong Kong University of Science and Technology; Yan Guo, Peking University; and Chenggang Xu, University of Hong Kong, "What Makes Privatization Work? The Case of China."
Discussant: Gary Jefferson, Brandeis University

Irene Brambilla, Yale University and NBER; Galina Hale, Federal Reserve Bank of San Francisco; and Cheryl Long, Colgate University, "Foreign Direct Investment and Incentives to Innovate and Imitate."
Discussant: C. Fritz Foley, Harvard University and NBER

Kalina Manova, Stanford University and NBER, and Zhiwei Zhang, IMF, "China's Exporters and Importers: Firms, Products, and Trade Partners."
Discussant: Amit Khandelwal, Columbia University

Li Han, Stanford University, "Marketing Politics? Economic Reforms and the Selection of Political Elites in China."
Discussant: Yasheng Huang, MIT

Wang provides new evidence on the impact of private property rights on entrepreneurship. He explores this issue in the context of a housing reform in urban China that allowed state employees renting state-owned housing the opportunity to buy their homes at subsidized prices. Using the reform as an exogenous change in the capital constraints and mobility costs that influence individuals' entry into entrepreneurship, he estimates that it increased self-employment. He develops a model of job choice to test two mechanisms that might explain how the reform increased entrepreneurship, noting that it increased the ability of individuals to finance entrepreneurial ventures by allowing them to capitalize on the value of the real estate. The unbundling of housing benefits from state employment also contributed to the increase in entrepreneurship by facilitating labor mobility out of the state sector.

Sex ratios (males to females) rose markedly in China in the last two decades, and crime rates nearly doubled. In their paper, Edlund, Li, Yi, and Zhang examine whether the two are causally linked. High sex ratios imply fewer married men, and marriage has been conjectured to be a socializing force. The paper exploits the quasi-natural experiment generated by the Chinese one-child policy, a policy that is widely held to be behind the surplus of sons. While a national policy, its implementation was local. At the provincial level, implementation was unrelated to contemporaneous economic characteristics of the province. Instead, individual characteristics of the provincial party secretary influenced the timing. Moreover, leaders were systematically rotated such that ten years on, leader characteristics were serially uncorrelated. Using annual province-level data for the period 1988-2004, the authors show that a 0.01 increase in the sex ratio raised violent and property crime rates by some 3 percent, suggesting that the rise in excess males may account for up to one-seventh of the overall rise in crime.

Wei and Zhang note that Chinese households save about 25 percent of their income, contributing to one of the world's highest current-account surpluses. The life-cycle theory and precautionary savings motive provide only an incomplete explanation for this. This paper proposes a new hypothesis: China's high and rising sex ratio imbalance -- too many boys relative to girls at birth -- attributable to a combination of a strict family planning policy, parental preference for sons, and inexpensive abortion technologies, may have induced the Chinese to postpone consumption in favor of wealth accumulation. To avoid condemning their sons to life-long bachelorhood, families with a boy raise their saving rates. Other families do not reduce their savings rates because there is a spillover channel. Across provinces, local saving rates are strongly positively associated with local sex-ratio imbalances, the authors find, after accounting for demographics and social safety nets. This effect is stronger in rural areas than in urban areas. Household-level data also support this hypothesis: families with a son tend to save more in regions with a more skewed sex ratio, holding constant various household features. Households with daughters do not reduce their savings in these regions. The increase in sex ratios accounts for about half of the increase in household savings nationally.

Using Chinese data, Fan, Jin, and Zheng examine the internal capital market in emerging market business groups. They focus on two aspects that are less prominent in the developed markets: cross-financing to get over severe financing constraints that are often prevalent in emerging market economies, and the rampant expropriation of minority shareholders under the weak corporate governance environment. The authors find that, from the perspective of the collection of firms affected by the internal capital market, the market is the least inefficient when weak corporate governance induces more tunneling activities and there is no big need to mitigate financing constraints. On the other hand, when corporate governance is relatively stronger, and firms have a pressing need to use the internal capital market to mitigate financing constraints, the efficiency of the internal capital market is highest.

A fundamental question in finance is whether and how removing barriers is associated with efficiency gains. Cheung, Jiang, Kai Li, and Wang study this question using share issue privatization in China that took place through the split-share structure reform. Prior to the reform, domestic A-shares were divided into tradable and non-tradable shares with identical cash flow and voting rights. Under the reform, non-tradable shareholders negotiate a compensation plan with tradable shareholders in order to make their shares tradable. The key predictions are: 1) the size of compensation made by the non-tradable shareholders to the tradable share holders is negatively correlated with the bargaining power of non-tradable share holders; 2) the size of compensation is positively correlated with the gain in risk sharing; and 3) the size of compensation is negatively correlated with firm performance; results are consistent with our model's predictions. The authors conclude that better risk sharing is an important consideration in China's share issue privatization.

Iyer, Meng, and Qian analyze the impact of housing reforms in China. Their preliminary results indicate that urban housing reforms are associated with more households working in the private sector; households eligible for housing loans are more likely to be running private businesses after the reforms. These reforms do not increase households' access to non-housing loans, or the propensity of households to invest in housing improvements.

Gan, Guo, and Xu use a unique hand-collected nationwide survey to study China's privatization, the largest in human history. They find that privatization in China has improved performance, but only for firms bought out by managers (MBOs). Consistent with improved performance, MBO firms are less likely to be influenced by the state in their daily operation and are more likely to take various restructuring measures. The authors also find that city governments with stronger fiscal discipline, and with fewer political burdens of disposing of laid-off workers, tend to use the MBO method to privatize.

Brambilla, Hale, and Long explore a new channel for FDI spillovers on domestic firms in the host country that operates through imitation of original products. They develop a model of heterogeneous firms and allow domestic firms to choose among three alternatives: 1) not introduce any new products, 2) introduce a new product line (innovate), or 3) develop a variety that is a very close substitute to an existing product line developed by another firm (imitate). The presence of foreign firms generates spillovers via increased incentives for imitation, as foreign firms introduce a range of original products that are vertically differentiated with respect to original domestic products. The model generates testable implications that allow the authors to distinguish empirically between the effects of FDI on true innovation and on imitation. They test the model's predictions using firm-level panel data for China and find that, consistent with the model, increased FDI presence in a given industry leads to more limitation, but not necessarily more innovation, by domestic firms.

Manova and Zhang provide a detailed overview of China's participation in international trade. Using newly available data on the universe of globally engaged Chinese firms over the 2003-5 period, they document the distribution of trade flows, product- and trade-partner intensity across both exporting and importing firms, and they study the relationship between firms' intensive and extensive margins of trade. They also compare trade patterns across firms of different organizational structure, distinguishing between domestic private firms, domestic state-owned firms, foreign-owned firms, and joint ventures. Exploring the variation in foreign ownership across sectors, they find results consistent with recent theoretical and empirical work on the role of credit constraints and contractual imperfections in international trade and investment.

Han argues that economic liberalization, by reducing the extent to which an au-tocrat can directly control economic resources, induces democratization. This paper suggests that in post-reform China, the composition of the ruling Communist Party membership was altered so as to keep political and economic control aligned. National survey data show that membership increased more among educated indi- viduals with greater private-sector opportunities. Exploiting exogenous variation in college graduates' labor market outside options reveals that such a change is driven mainly by the Party's increased demand for educated individuals working in the growing private sector. Such a strategy, of co-opting a new economic elite, could help to increase the Party's survival probability and strengthen its commitment to economic reforms.

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Entrepreneurship Working Group

The NBER's Working Group on Entrepreneurship met in Cambridge on October 3. Group Director Josh Lerner, of NBER and Harvard University, organized the meeting. These papers were discussed:

Luis Cabral, New York University, and Zhu Wang, Federal Reserve Bank of Kansas City, "Spin-Outs: Theory and Evidence"

Mark Doms, Federal Reserve Bank of San Francisco; Ethan Lewis, Dartmouth College; and Alicia Robb, University of California, Santa Cruz, "Local Labor Market Endowments, New Business Characteristics, and Performance"
Discussant: Bart Hamilton, Washington University

Larry Chavis, University of North Carolina at Chapel Hill; and Leora Klapper and Inessa Love, The World Bank, "Entrepreneurial Finance around the World: The Impact of the Business Environment on Financing Constraints"

James E. Rauch, University of California, San Diego and NBER, "Spinout Entrepreneurship, Crony Capitalism, and Development"
Discussant: Chris Woodruff, University of California, San Diego

Jerry G. Thursby, Georgia Institute of Technology, and Marie C. Thursby, Georgia Institute of Technology and NBER, "Faculty Participation in Licensing: Implications for Research"
Discussant: Lee Fleming, Harvard University

Ola Bengtsson, Cornell University, and Berk A. Sensoy, University of Southern California, "Investor Abilities and Financial Contracting: Evidence from Venture Capital"

Yael V. Hochberg, Northwestern University; Alexander Ljungqvist, New York University; and Annette Vissing-Jorgenson, Northwestern University and NBER, "Informational Hold-Up and Performance Persistence in Private Equity"
Discussant Morten Sorensen, Columbia University and NBER

Cabral and Wang develop a passive learning model of firm entry by spin-off: a firm's employees leave their employer and create a new firm when they learn that they are good entrepreneurs (type I spin-offs), or they learn that their employer's prospects are bad (type II spin-offs). Here, the theory predicts a high correlation between spin-offs and parent exit, especially when the parent is a low-productivity firm. This correlation may correspond to two types of causality: either spin-off causes firm exit (type I spin-offs) or firm exit causes spin-off (type II spin-offs). The authors test and confirm this and other predictions of the model on a unique dataset of the U.S. automobile industry. Finally, they discuss policy implications regarding "covenant not to compete" laws.

It is often asserted that a highly educated workforce is vital to improving the competitive position of American businesses, especially by boosting entrepreneurship. Doms, Lewis, and Robb evaluate this contention using population Census data and a nationally representative panel of startup firms. They examine how the education and skill level of the local labor force are related to the creation and success of new businesses. They find that areas with more skilled labor also have higher rates of self-employment and more skilled entrepreneurs, and that the education of the business owner is strongly linked to improved business outcomes. Potentially consistent with the popular view, the authors also find that, conditional on the owner's education, higher education levels in the local market are positively correlated with improved business outcomes.

Chavis, Klapper and Love use a unique database that contains over 70,000 firms in over 100 countries to systematically study the use of different financing sources for new and young firms. As expected, they confirm that, in all countries, younger firms rely less on bank financing and more on informal financing. However, they also find that younger firms have better access to bank finance in countries with better rule of law and better credit information, and that the reliance of young firms on informal finance decreases with the availability of credit information. Overall, these results suggest that improving the legal environment and availability of credit information would be disproportionately beneficial for promoting access to formal finance by young firms.

Recently collected data show that, within any manufacturing industry, vertically integrated firms tend to have larger, higher productivity plants, to account for the bulk of sales, and to sell externally most of the inputs that they produce. In a weak contracting environment that characterizes less developed countries (LDCs), vertically integrated firms are vulnerable to "spinouts" by employees who make specialized inputs (formerly provided internally) subject to hold-up and who capture the profits formerly made from external sales of generic inputs. Rauch shows that this vulnerability leads to inefficiently low entry and helps to explain the "missing middle" in the size distribution of LDC firms and the limited local content of LDC exports. Vertically integrated firms can fight back by hiring "cronies" to manage their input divisions: members of networks that informally sanction hold-ups, or children who keep profits "in the family" even if they spin out. This paper predicts the association of co-ethnic networks with high rates of entrepreneurship and the prominence of family-owned business groups in LDC manufacturing. The government can achieve a higher level of entry at minimum cost by directing subsidies to vertically integrated family firms, but only if families with competent children can be identified ex ante.

Thursby and Thursby exploit a unique database on disclosure of research and invention by faculty at eleven major U.S. universities over a period of 17 years to explore whether university licensing has compromised basic research. They study the relationships among disclosures to industry and federally sponsored research, publications, citations, "expected citations," and basic publications. They find that recent disclosure activity has a positive effect on research funding by industry and the federal government. But, if faculty disclose their results multiple times, then the positive effect on federal funding can disappear and become negative. Both recent and repeated disclosures increase the faculty member's publication count, as well as the importance of these publications in terms of citation. There is also weak evidence that disclosure activity is associated with increases in other measures of "basic" research. Finally, the authors examine life-cycle effects and find that the ability to attract funding and the rate of publication increase as the faculty member ages, but at a decreasing rate. Research also tends to be less basic as faculty members age. The authors further find that post tenure, both types of funding decrease and work becomes less basic.

Bengtsson and Sensoy ask how investors' abilities to mitigate agency problems in non-contractual ways will affect contract design. Their empirical setting is the venture capital (VC) industry, in which there are substantial agency problems, considerable flexibility in contract design, and wide variation in the abilities of VCs to monitor and add value to their portfolio companies. The analysis uses a new database of contractual provisions for investments by 646 private-partnership VCs in 1,266 startup companies over 1,534 investment rounds. The authors discover that more experienced VCs, who likely have better monitoring abilities and whose withdrawal as active, value-added investors is more costly to entrepreneurs, are less likely to use contracts that give them greater cash flow rights if company performance is poor. This result survives a battery of controls for company characteristics, including valuation, as well as specifications that control for endogenous selection effects. The relation between VC experience and downside protections is weaker when agency problems are less severe.

Hochberg, Ljungqvist, and Vissing-Jorgenson first propose and then test a theory of learning and informational hold-up in the VC market. Their model predicts that higher returns on the current fund increase: the probability that a VC will raise a follow-on fund, the size of the follow-on fund, and the performance fee investors are charged in the follow-on fund. If learning is asymmetric, such that incumbent investors learn more about fund managers' skill than potential new investors do, the model also predicts persistence in returns, poor performance among first-time funds, persistence in investors from fund to fund, and over-subscription in follow-on funds raised by successful fund managers. The empirical evidence is consistent with these predictions.

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Economic Fluctuations and Growth

NBER's Program on Economic Fluctuations and Growth met on October 17 at the Federal Reserve Bank of Chicago. Organizers Janice C. Eberly, NBER and Northwestern University, and Giuseppe Moscarini, NBER and Yale University, chose the following papers to discuss:

Robert B. Barsky, University of Michigan and NBER, and Eric Sims, University of Michigan, "Information, Animal Spirits, and the Meaning of Innovations in Consumer Confidence"
Critic: John H. Cochrane, University of Chicago and NBER

Emmanuel Farhi, Harvard University and NBER and Ivan Werning, MIT and NBER, "The Political Economy of Nonlinear Capital Taxation"
Critic: Narayana R. Kocherlakota, University of Minnesota and NBER

Charles I. Jones, University of California, Berkeley and NBER, "Intermediate Goods and Weak Links: A Theory of Economic Development"
Critic: Richard Rogerson, Arizona State University and NBER

Steven J. Davis, University of Chicago and NBER; R. Jason Faberman, Federal Reserve Bank of Philadelphia; John Haltiwanger, University of Maryland and NBER; and Ron Jarmin and Javier Miranda, U.S. Census Bureau, "Business Volatility, Job Destruction, and Unemployment"
Critic: Ruediger Bachmann, University of Michigan

Arvind Krishnamurthy and Annette Vissing-Jorgensen, Northwestern University and NBER, "The Aggregate Demand for Treasury Debt"
Critic: Henning Bohn, University of California, Santa Barbara

Michael Woodford, Columbia University and NBER, "Information-Constrained State-Dependent Pricing"
Critic: Ariel Burstein, University of California, Los Angeles and NBER

Innovations to measures of consumer confidence convey incremental information about economic activity far into the future. Barsky and Sims compare the shape of impulse responses to confidence innovations in the data with the predictions of a calibrated New Keynesian model. They find little evidence of a strong causal channel from autonomous movements in sentiment to economic outcomes (the "animal spirits" interpretation). Rather, these impulse responses support an alternative hypothesis: that the surprise movements in confidence reflect information about future economic prospects (the "information" view). The authors conclude that confidence innovations are best characterized as noisy measures of changes in expected productivity growth over a relatively long horizon.

Farhi and Werning study efficient nonlinear taxation of labor and capital in a dynamic Mirrleesian model incorporating political economy constraints. Their main result is that the marginal tax on capital income is progressive, in the sense that richer agents face higher marginal tax rates. Per capita income in the richest countries of the world exceeds that in the poorest countries by a factor of more than 50. What explains this enormous difference? In his paper, Jones returns to two old ideas in development economics; he proposes that linkages and complementarity are at the heart of the explanation.

First, linkages between firms through intermediate goods deliver a multiplier similar to the one associated with capital accumulation in a neoclassical growth model. Because the intermediate goods' share of revenue is about one half, this multiplier is substantial. Second, just as a chain is only as strong as its weakest link, problems at any point in a production chain can reduce output substantially if inputs enter production in a complementary fashion. Jones builds a model to quantify these forces and shows that it can easily generate 50-fold aggregate differences in income.

Unemployment inflows fell from 4 percent of employment per month in the early 1980s to 2 percent or less by the mid-1990s and thereafter. U.S. data also show a secular decline in the job destruction rate and the volatility of firm-level employment growth rates. Davis, Faberman, Haltiwanger, Jarmin, and Miranda interpret this decline as a decrease in the intensity of idiosyncratic labor demand shocks, a key parameter in search and matching models of unemployment. According to these models, a lower intensity of idiosyncratic shocks produces less job destruction, fewer workers flowing through the unemployment pool, and less frictional unemployment. To evaluate the importance of this theoretical mechanism, the authors relate industry-level unemployment flows from 1977 to 2005 to industry-level indicators for the intensity of idiosyncratic shocks. They find strong evidence that declines in the intensity of idiosyncratic labor demand shocks drove big declines in the incidence and rate of unemployment. This evidence implies that the unemployment rate has become much less sensitive to cyclical movements in the job-finding rate.

Krishnamurthy and Vissing-Jorgensen show that the U.S. debt-to-GDP ratio is negatively correlated with the spread between corporate bond yields and Treasury bond yields. This result holds even after they control for the default risk on corporate bonds. The authors argue that the corporate bond spread reflects a convenience yield that investors attribute to Treasury debt. They show that regulatory demanders of Treasuries, including foreign central banks, have inelastic demand curves, and they estimate the effect that these buyers have on Treasury yields. They also discuss the implications for the aggregate value of Treasury convenience, the financing of the U.S. deficit, the behavior of interest rate swap spreads, and investors' portfolio choices.

Woodford generalizes the standard (full-information) model of state-dependent pricing in which decisions about when to review a firm's existing price must be made on the basis of imprecise awareness of current market conditions. He endogenizes the imperfect information using a variant of the theory of "rational inattention" proposed by Sims. This results in a one-parameter family of models, indexed by the cost of information, which nests both the standard state-dependent pricing model and the Calvo model of price adjustment as limiting cases (corresponding to an information cost of zero and an unboundedly large information cost, respectively). For intermediate levels of the information cost, the model is equivalent to one proposed by Caballero and Engel, but it provides an economic motivation for the hazard function and very specific predictions about its form. For moderate levels of the information cost, the Calvo model of price-setting is a fairly accurate approximation to the exact equilibrium dynamics, except in the case of (infrequent) large shocks.

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Market Microstructure

The NBER's Working Group on Market Microstructure met on October 24 in Cambridge. Group Director Bruce Lehmann of University of California, San Diego, Eugene Kandel, Hebrew University, Jerusalem, and Avanidhar Subrahmanyam, University of California, Los Angeles, jointly organized the meeting. These papers were discussed:

Ioanid Rosu, University of Chicago, "Liquidity and Information in Order Driven Markets"
Discussant: Uday Rajan, University of Michigan

Paolo Pasquariello, University of Michigan, and Clara Vega, Federal Reserve Board, "Strategic Cross-Trading in the U.S. Stock Market"
Discussant: Bruce Mizrach, Rutgers University

Chiraphol Chiyachantana, Singapore Management University, and Pankaj Jain, University of Memphis, "The Opportunity Cost of Inaction in Financial Markets: An Analysis of Institutional Decisions and Trades"
Discussant: Sunil Wahals, Arizona State University

Azi Ben-Rephael and Avi Wohl, Tel Aviv University, and Ohad Kadan, Washington University in St. Louis, "The Diminishing Liquidity Premium"

Discussant: Ronnie Sadka, Boston College

Anna Obizhaeva, University of Maryland, "Price Impact and Spread: Application of Bias-Free Estimation Methodology to Portfolio Transitions"
Discussant: Charles Jones, Columbia University

Alex Boulatov and Thomas George, University of Houston, "Securities Trading when Liquidity Providers are Informed"
Discussant: Ronald Goettler, University of Chicago

Using a dynamic model of an order-driven market, Rosu analyzes the interaction between liquidity traders and informed traders. Agents choose freely between limit and market orders by trading off execution price and waiting costs. In equilibrium, informed and patient traders generally submit limit orders, except when the fundamental value of the asset that they privately observe is far from the current market-inferred value, in which case they become impatient and submit a market order. As a result, a market buy order can be seen as an unambiguously positive signal; by contrast, a limit buy order is typically a weaker positive, and in some cases even a negative, signal. Rosu's model generates a rich set of relationships among prices, spreads, trading activity, and volatility. In particular, the order flow is autocorrelated if and only if there are informed traders in the market, and the autocorrelation increases with the percentage of informed traders. Higher volatility and lower trading activity generate larger spreads while, after controlling for volatility and trading activity, a higher percentage of informed traders surprisingly generate smaller spreads.

Pasquariello and Vega provide a theory and new empirical evidence of cross-price impact - that is, the permanent impact of informed trades in one asset on the prices of other (either related or fundamentally unrelated) assets -- in the U.S. stock market. They develop a model of multi-asset trading in the presence of two realistic market frictions: information heterogeneity and imperfect competition among informed traders. In that setting, they show cross-price impact to be the equilibrium outcome of strategic trading activity among risk-neutral speculators across many assets in order to mask their information advantage about some other assets. The authors find strong, robust evidence of cross-asset informational effects in a comprehensive sample of the trading activity in NYSE and NASDAQ stocks between 1993 and 2004.

Chiyachantana and Jain present the first comprehensive analysis of a frequently ignored component of implementation shortfall: the opportunity cost of institutional decisions that are not executed. Of total decisions made, over 8 percent are partly or wholly unfilled. The opportunity costs of this failure to trade are 24 basis points, or $20 billion in the sample period, much higher than the price impact and five times that of commissions. There is a significant asymmetry in the opportunity cost of buy-versus-sell decisions based on whether market conditions are bullish or bearish. Opportunity costs decrease with firm size, speed of transaction, number of brokers, and exchange listing, whereas they increase with market volatility. Opportunity loss from non-execution persists and increases slightly with the passage of time. Transaction-cost risks are higher for small stocks and volatile stocks.

Previous evidence suggests that less liquid stocks yield higher average returns. Using NYSE data, Ben-Rephael, Kadan, and Wohl demonstrate that both the sensitivity of returns to liquidity and the liquidity premium have declined significantly over the past four decades to levels that cannot be statistically distinguished from zero. Furthermore, the profitability of trading strategies based on buying illiquid stocks and selling liquid stocks has declined significantly over the past four decades. The authors offer possible explanations for these results related to the proliferation of hedge funds, index funds, and exchange-traded funds.

Obizhaeva develops a bias-free methodology for estimating the parameters of trading costs and applies it to a unique dataset of portfolio transition trades. She estimates price impact and effective spread in both traditional markets and crossing networks for the period 2001 through 2005. These estimates vary across securities: price impact increases with the stocks' overall trading volume and volatility; in contrast, effective spread decreases with these characteristics. For thinly traded securities, trading costs are almost invariant with respect to trade size, and spread-related payments account for their largest fraction. For actively traded securities, trading costs are very sensitive to trade size, and spread-related payments are less significant. The positive association between price impact and trading volume is counterintuitive and not easily explained within existing market microstructure models. Obizhaeva outlines potential explanations that might underly these patterns.

Boulatov and George study securities trading when informed agents provide liquidity, either because dealers have superior access to market information or because informed traders exploit strategies involving limit orders. The authors show that both informed dealers and informed traders can profit more at the expense of uninformed liquidity traders when markets are transparent than when markets are opaque. This is because transparency serves as a coordination device that reduces competition among informed traders. When the informed are allowed to choose whether to trade via market orders or price-contingent (limit) orders, informed traders will gravitate toward limit orders. The endogenous allocation of traders to order types maximizes competition among the informed, thereby minimizing expected losses to liquidity traders. The predictions here are consistent with recent empirical evidence: that the price impact of limit-order arrivals is greater than that of market-order executions. This suggests that the usual approach in empirical microstructure research, of measuring the impact of private information as the trade-correlated permanent component of price changes, significantly understates the true importance of private information securities markets.

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Labor Studies

NBER's Program on Labor Studies met in Cambridge on October 31. Program Director Richard B. Freeman and NBER Research Associate Lawrence F. Katz, both of Harvard University, organized the meeting and chose the following papers to discuss:

Jesse Rothstein, Princeton University and NBER; Stephanie Cellinis, George Washington University; and Fernando Ferreira, University of Pennsylvania and NBER, "The Value of School Facilities: Evidence from a Dynamic Regression Discontinuity Design."

Amalia Miller, University of Virginia, and Carmit Segal, Universitat Pompeu Fabra, "Does Temporary Affirmative Action Produce Persistent Effects? A Study of Black and Female Employment in Law Enforcement"

William Kerr, Harvard University, and William Lincoln, University of Michigan, "The Supply Side of Innovation: H-1B Visa Reforms and U.S. Ethnic Invention"

Morris M. Kleiner, University of Minnesota and NBER, and Alan B. Krueger, Princeton University and NBER, "The Prevalence and Effects of Occupational Licensing"(NBER Working Paper No.14308)

Douglas Almond, Columbia University and NBER; Joseph J. Doyle, MIT and NBER; Amanda Kowalski, MIT; and Heidi Williams, Harvard University, "Estimating the Marginal Returns to Medical Care: Evidence from At-Risk Newborns"

Janet Currie, Columbia University and NBER; Mark Stabile, University of Toronto; and Phongsack Manivong and Leslie L. Roos, University of Manitoba: "Child Health and Young Adult Outcomes"

Rothstein, Cellinis, and Ferreira draw on the unique characteristics of California's system of school finance, comparing districts in which school bond referenda passed or failed by narrow margins, to estimate the impact of investments in school facilities. They find that passing a referendum causes immediate, sizable increases in home prices, implying a willingness on the part of marginal homebuyers to pay $1.50 or more for each dollar per pupil of facility spending. These effects do not appear to be driven by changes in the income or racial composition of homeowners. While the authors find suggestive evidence that bond passage leads to increases in student test scores, this effect cannot explain more than a small portion of the housing price effect, indicating that bond passage leads to improvements in other dimensions of school output (for example, safety) that may be not captured by test scores.

Miller and Segal exploit the rich variation in timing and outcomes of 140 employment discrimination lawsuits brought against U.S. law enforcement agencies to estimate the cumulative employment effects of temporary, externally imposed affirmative action (AA). Using confidential administrative data on 479 of the largest state and local agencies spanning a period of 33 years, they show that AA plans increase black employment for all ranks of police, averaging between 4.2 and 6.5 percentage points over and above any prevailing trends in the country. They find no erosion of black employment gains from AA in the decade and a half following AA termination. Nevertheless, in departments whose plans are terminated, they find a significant decrease in black employment growth relative to departments whose plans continue. In contrast to their findings for blacks, the authors find only marginal employment gains for women and none at higher ranks.

Kerr and Lincoln exploit large changes in the H-1B visa program. They find that fluctuations in levels of H-1B admissions significantly influence the rate of Indian and Chinese patenting in cities and firms dependent upon the program. They also find weak crowding-in effects, such that total invention increases with higher admission levels.

Using data from a specially designed Gallup survey, Kleiner and Krueger provide the first nation-wide analysis of the labor market implications of occupational licensing for the United States. They find that in 2006, 29 percent of the workforce was required to hold an occupational license from a government agency; that is a higher percentage than was found in studies that rely on state-level data. Workers who have higher levels of education are more likely to work in jobs that require a license. Union workers and government employees are more likely to have a license requirement than nonunion or private sector employees. Estimates here suggest that licensing has about the same quantitative impact on wages as unions -- that is about 15 percent -- but unlike unions, which reduce variance in wages, licensing does not significantly reduce wage dispersion for individuals in licensed jobs.

Almond, Doyle, Kowalski, and Williams estimate the marginal returns to medical care for at-risk newborns by comparing health outcomes and provision of medical treatment on either side of common risk classifications, most notably the "very low birth weight" threshold of 1500 grams. First, using data on the census of U.S. births in available years from 1983-2002, they find that newborns with birth weights just below that threshold have lower one-year mortality rates than newborns with birth weights just above this cutoff -- even though mortality risk in general tends to decrease with birth weight. Second, using hospital discharge records for births in five states in available years from 1991-2006, the researchers find that newborns with birth weights just below 1500 grams have discontinuously higher charges and frequencies of specific medical inputs. They estimate a $4,000 increase in hospital costs as birth weight approaches 1500 grams from above, relative to mean hospital costs of $40,000 just above 1500 grams. Taken together, these estimates suggest that the cost of saving one "newborn statistical life" -- that is, the cost of reducing the number of expected newborn deaths by one -- for newborns with birth weight near 1500 grams, is on the order of $500,000 to $650,000 in 2006 dollars.

Previous research has shown a strong connection between birth weight and a child's future health outcome. To address some important questions not considered in that work, Currie, Stabile, Manivong, and Roos use a unique dataset based on public health insurance records for 50,000 children born between 1979 and 1987 in the Canadian province of Manitoba. These children were followed until 2006, and their records were linked to provincial registries with data on health outcomes. The authors compare children with health conditions to their own siblings born at most nine years apart, and they control for health at birth. They find that health problems in early childhood are significant determinants of outcomes linked to adult socioeconomic status.

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Political Economy

NBER's Program on Political Economy met in Cambridge on October 31. NBER Research Associate Romain Wacziarg of University of California, Los Angeles organized the meeting. These papers were discussed:

Pedro Dal Bó, Brown University and NBER, and Andrew Foster and Louis Putterman, Brown University, "Institutions and Behavior: Experimental Evidence on the Effects of Democracy"
Discussant: Alan Gerber, Yale University and NBER

Verónica Amarante and Andrea Vigorito, Universidad de la Republica, Montevideo; Marco Manacorda, London School of Economics; and Edward Miguel, University of California , Berkeley and NBER, "Government Transfers and Political Support"
Discussant: Rohini Pande, Harvard University

Pol Antràs, Harvard University and NBER, and Gerard Padró i Miquel, London School of Economics and NBER, "Foreign Influence and Welfare" (NBER Working Paper No. 14129)
Discussant: Arnaud Costinot, MIT and NBER

Alberto Alesina, Harvard University and NBER, and Ekaterina Zhuravskaya, New Economic School, "Segregation and the Quality of Government in a Cross-Section of Countries" (NBER Working Paper No.14316)
Discussant: Benjamin Olken, MIT and NBER

Nathan Nunn, Harvard University and NBER, and Leonard Wantchekon, New York University: "The Trans-Atlantic Slave Trade and the Origins of Mistrust within Africa"
Discussant: William Easterly, New York University and NBER

Adam Meirowitz, Princeton University, and Kenneth Shotts, Stanford University, "Pivots Versus Signals in Elections"
Discussant: Steven Callander, Northwestern University

Bo, Foster, and Putterman describe a novel experiment on the effect of a policy designed to encourage cooperation in a prisoner's dilemma game. The effect of this policy on the level of cooperation is greater when it is chosen democratically by the subjects rather than being imposed exogenously. In contrast to earlier studies, their experimental design allows them to control for selection effects (for example, those who choose the policy may be affected differently by it). Their results imply that democratic institutions may affect behavior, in addition to having an effect through the choice of policies. More generally, their findings have implications for empirical studies of treatment effects in other contexts: the effect of a treatment can differ depending on whether it is endogenous or exogenous.

Amarante, Vigorito, Manacorda, and Miguel estimate the impact of a large anti-poverty program - the Uruguayan PANES - on political support for the government that puts it in place. They find that program-beneficiary households are 25 to 31 percentage points more likely to favor the current government (relative to the previous government). The program's impacts on political support are larger among poorer households and for those near the center of the political spectrum, as predicted by the probabilistic voting model in political economy. The researchers estimate that the annual cost to the government of increasing their political support by 1 percent is on the order of US$89 million, or 1.7 percent of annual government expenditures.

Antras and Miquel develop a model of foreign influence and apply it to the study of optimal tariffs. They show that policies end up maximizing a weighted sum of domestic and foreign welfare; foreign influence may enhance welfare, from the point of view of aggregate world welfare, because it helps to alleviate externalities arising from the cross-border effects of policies. However, foreign influence can prove harmful in the presence of large imbalances in power across countries. The researchers apply their model of foreign influence to the study of optimal trade policy, deriving a modified formula for the optimal import tariff. They show that a country's import tariff is more distorted when the influenced country is small relative to the influencing country, and when natural trade barriers between the two countries are small.

Alesina and Zhuravskaya produce a new compilation of data on ethnic, linguistic, and religious composition at the sub-national level for a large number of countries. They then use the data to measure segregation of different ethnic, religious, and linguistic groups within the same country. They also attempt to correlate measures of segregation with measures of quality of the polity and policymaking, and they construct an instrument to overcome the endogeneity problem (that arises because groups move within country borders, partly in response to policies). Their results suggest that more ethnically and linguistically segregated countries, that is, those where groups live more spatially separately, have a substantially lower quality of government. In contrast, they find no relationship between religious segregation and the quality of government.

Nunn and Wantchekon investigate the historical origins of mistrust within Africa. Combining contemporary household survey data with historical data on slave shipments by ethnic group, they show that individuals whose ancestors were heavily threatened by the slave trade exhibit less trust in others and less trust in the government today. The researchers confirm that this relationship is causal by instrumenting the historic intensity of the slave trade by the ancestor's historic distance from the coast, controlling for the respondent's current distance from the coast. They show that the relationship between the slave trade and an individual's level of trust cannot be explained by the slave trade's effect on factors external to the individual, such as domestic institutions, or the legal environment. Instead, the evidence shows that the effects of the slave trade work primarily through vertically transmitted factors that are internal to the individual, such as cultural norms of behavior.

Meirowitz and Shotts consider a two-period model of elections in which voters have private information about their policy preferences. A first-period vote can have two types of consequences: it may be pivotal in the first election, and it provides a signal that affects candidates' positions in the second election. Pivot events are exceedingly unlikely, but when they occur the effect of a single vote is enormous. In contrast, vote totals always have some signaling effect, but the effect of a single vote is small. The authors investigate which effect -- pivot or signaling -- drives equilibrium voting behavior in large electorates.

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Public Economics

NBER's Program on Public Economics met at Stanford University on November 6-7. Organizers Raj Chetty and Emmanuel Saez, both of the University of California, Berkeley and NBER, chose the following papers to discuss:

Amy Finkelstein, MIT and NBER; Liran Einav, Stanford University and NBER; and Mark R. Cullen, Yale University, "Estimating Welfare in Insurance Markets Using Variation in Prices" (NBER Working Paper No. 14436)
Discussant: Dan Silverman, University of Michigan and NBER

Henrik Kleven, London School of Economics, and Wojciech Kopczuk, Columbia University and NBER, "Transfer Program Complexity and the Take-up of Social Benefits" (NBER Working Paper No. 14301)


Discussant: B. Douglas Bernheim, Stanford University and NBER

Hanming Fang and Peter Arcidiacono, Duke University and NBER, and Esteban Aucejo, Duke University, "Does Affirmative Action Lead to Mismatch? A New Test and Evidence"
Discussant: Caroline M. Hoxby, Stanford University and NBER

David Albouy, University of Michigan and NBER, "Are Big Cities Really Bad Places to Live? Improving Quality-of-Life Estimates Across Cities" (NBER Working Paper No. 14472)
Discussant: Patrick Kline, University of California, Berkeley

Fernando Ferreira, University of Pennsylvania and NBER; Stephanie Riegg Cellini, George Washington University; and Jesse Rothstein, Princeton University and NBER, "The Value of School Facilities: Evidence from a Dynamic Regression Discontinuity Design"
Discussant: Michael Lovenheim, Stanford University

Raj Chetty and Emmanuel Saez, "Information and Behavioral Response to Taxation: Evidence from an Experiment with EITC Clients at H&R Block"
Discussant: J. Karl Scholz, University of Wisconsin and NBER

Wojciech Kopczuk, and Roger H. Gordon, University of California, San Diego and NBER, "The Choice of the Personal Income Tax Base"
Discussant: Matt Weinzerl, Harvard University

Einav, Finkelstein, and Cullen show how standard consumer and producer theory can be used to estimate welfare in insurance markets with selection. Their key observation is that the same price variation needed to identify the demand curve also identifies how costs vary as market participants endogenously respond to price. With estimates of both the demand and cost curves, welfare analysis is straightforward. The authors illustrate their approach by applying it to the employee health insurance choices at Alcoa, Inc. They detect adverse selection in this setting, but estimate that its quantitative welfare implications are small, and not obviously remediable by standard public policy tools.

Kleven and Kopczuk model complexity in social programs as a byproduct of efforts to screen between deserving and undeserving applicants. More rigorous screening technology may have desirable effects on targeting efficiency, but the associated complexity introduces transaction costs into the application process and may induce incomplete take up. The authors' model assumes a government interested in ensuring a minimum income level for as many deserving individuals as possible. It characterizes optimal programs as when policymakers can choose the rigor of screening (and associated complexity) along with a benefit level and an eligibility criterion. Optimal programs that are not universal always feature a high degree of complexity. Although the government is interested only in ensuring a minimum benefit level, the optimal policy may feature benefits higher than this target minimum. This is because benefits generically screen better than either eligibility criteria or complexity. The authors present simulations with respect to budget size, ability distribution, complexity costs, and stigma and discuss their results in light of empirical findings for public programs in the United States.

Arcidiacono, Aucejo, and Fang argue that once they take into account the rational enrollment decisions of students, mismatch (in the sense that the intended beneficiary of affirmative action admission policies are made worse off) could occur only if selective universities possess private information about students' post-enrollment treatment effects. This necessary condition for mismatch provides the basis for a new test. The authors propose an empirical methodology to test for private information in such a setting. They implement it using data from Campus Life and Learning Project (CLL) at Duke. Preliminary evidence shows that Duke does possess private information that is a statistically significant predictor of a student's post-enrollment academic performance, but Duke's private information only explains a very small percentage of the variation in student performance. The authors also propose strategies to evaluate more conclusively whether the evidence of Duke private information has ge generated mismatch.

Hedonic estimates of quality of life across cities correspond to the cost-of-living in a city relative to its local wage level. Albouy adjusts this standard model to account for federal taxes, non-housing costs, and non-labor income, producing quality-of-life estimates different from those in the existing literature. This adjusted model produces city rankings that are positively correlated with those in the popular literature, and predicts how housing costs rise with wage levels, after controlling for amenities. Mild seasons, sunshine, and coastal location account for most quality-of-life differences; once these amenities are accounted for, quality of life does not depend on city size, contrary to previous findings.

Cellini, Ferreira, and Rothstein use the housing market to estimate the impact of investments in school facilities. Drawing on California's unique system of school finance, they compare districts in which school bond referenda passed, or failed by narrow margins. The authors account for the dynamic nature of bond referenda: the probability of future bond proposals depends on the outcomes of past elections. They show first that bond funds stick exclusively in the capital account, with no effect on current expenditures or other revenues. This suggests that the effect of referendum passage reflects the impact of improvements in the quality of school facilities. The authors find that passing a referendum causes immediate, sizable increases in home prices, implying an elasticity of home prices with respect to school spending of 0.5. They also find suggestive evidence that passage causes higher test scores several years later, once the bond-financed projects are complete. These effects do not by changes in the income and racial composition of local households. Finally, the magnitude of the price effect suggests that bond passage leads to improvements in other dimensions of school output (for example, safety) that may be not captured by test scores.

Chetty and Saez test whether providing information about the work incentives created by the Earned Income Tax Credit (EITC) amplifies its effects on labor supply. Conducting a randomized field experiment with 43,000 EITC claimants at H&R Block in which half the clients were provided simple, personalized information about the EITC schedule, they obtain three results. First, tax filers initially in the increasing and peak ranges of the EITC in the base year are more likely to locate near the peak of the EITC schedule after receiving the information. Provision of information reduces the rate of extreme poverty (earnings below $7,000) by 15 percent and also reduces the probability of moving into the phase-out range. Second, the bunching around the peak caused by information provision is stronger for tax filers who report self-employment income. However, there is increased bunching near the peak even among wage earners, suggesting that the information induced a real labor supply response. Third, for initially in the phase-out range, earnings are essentially unaffected by the provision of information, perhaps because tax professionals framed the work disincentive created by the EITC as being small. Overall, the changes in behavior induced by information are substantial: EITC subsidy rates would have to be increased by at least 20 percent ($10 billion) to generate responses of the same size.

Gordon and Kopczuk lay out theoretically and estimate empirically how best to use available information about each individual, in addition to earnings, when solving for the optimal tax base. In contrast to most of the literature on this topic, their paper shows how equity considerations may be incorporated quantitatively in the analysis. They find that the optimal tax base should include capital income, at least to some degree. In contrast to current practice, though, property tax payments and mortgage interest payments should not be deductible, because these deductions are costly on equity grounds, and presumably on efficiency grounds as well.

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International Finance and Macroeconomics

The NBER's Program on International Finance and Macroeconomics met in Cambridge on November 7. Organizers Charles Engel, NBER and University of Wisconsin, and Linda Tesar, NBER and University of Michigan, chose the following papers to discuss:

Cristina Arellano, University of Minnesota, and Ananth Ramanarayanan, Federal Reserve Bank of Dallas, "Default and Maturity Structure in Foreign Bonds"
Discussant: Olivier Jeanne, John Hopkins University

Anton Korinek, University of Maryland, "Regulating Capital Flows to Emerging Markets: An Externality View"

Discussant: Gita Gopinath, Harvard University and NBER

Lukasz A. Drozd, University of Wisconsin, and Jaromir B. Nosal, Columbia University, "Understanding International Prices: Customers as Capital"
Discussant: Paolo Pesenti, Federal Reserve Bank of New York and NBER

Ariel Burstein, University of California, Los Angeles and NBER, and Nir Jaimovich, Stanford University and NBER, "Understanding Movements in Aggregate and Product-Level Real Exchange Rates"
Discussant: David Weinstein, Columbia University and NBER

Hanno Lustig, University of California, Los Angeles and NBER; Nick Roussanov, University of Pennsylvania; and Adrien Verdelhan, Boston University, "Common Risk Factors in Currency Markets"
Discussant: Craig Burnside, Duke University and NBER

Yan Bai, Arizona State University, and Jing Zhang, University of Michigan, "Financial Integration and International Risk Sharing"
Discussant: Vivian Yue, New York University

Arellano and Ramanarayanan study the maturity composition and the term structure of interest rate spreads on government debt in emerging markets. When interest rate spreads rise, debt maturity shortens and the spread on short-term bonds is higher than on long-term bonds. To account for this pattern, the authors build a dynamic model of international borrowing, with endogenous default and multiple maturities of debt. Short-term debt can deliver higher immediate consumption than long-term debt; large long-term loans are not available because the borrower cannot commit to save in the near future towards repayment in the distant future. However, issuing long-term debt can insure against the need to rollover short-term debt at high interest rate spreads. The trade-off between these two benefits is quantitatively important for understanding the maturity composition in emerging markets. When calibrated to data from Brazil, the model matches the dynamics in the maturity of debt issuances and its co the level of spreads across maturities.

Korinek analyzes the external financing decisions of emerging market economies that are prone to collateral-dependent constraints. He demonstrates that most forms of capital flows into such economies impose a macroeconomic externality, leading decentralized agents to take on too much systemic risk, and making the recipient country more vulnerable to financial instability and crises. Every capital inflow entails future outflows in the form of repayments, dividends, or profit distributions. In states of the world when financing constraints in an economy become binding, capital outflows necessitate an increase in the current account and a reduction in aggregate demand. This puts pressure on the exchange rate and triggers a financial accelerator mechanism, that is a mutual feed-back cycle of depreciating exchange rates, deteriorating balance sheets, tightening financing constraints, and declining aggregate demand. Decentralized agents take prices as given and do not internalize that the capital outflow associated with their repayments contribute to the financial accelerator. As a result, they do not internalize the full social cost of such payments and take on too much systemic risk in their financing decisions. Korinek illustrates how these externalities can be quantified for different categories of capital flows using historical data from Indonesia, and describes a pecking order of financial flows that reflects the different magnitudes of the resulting externalities. Furthermore, he defines a social pricing kernel that describes the optimal magnitude of policy measures to restore social efficiency.

Drozd and Nosal develop a new theory of pricing-to-market driven by sluggish market shares. Their key innovation is a capital theoretic model of marketing in which relations with the customers are valuable. They discipline the introduced friction using a unique prediction of the model about the low short-run and high long-run price elasticity of international trade flows, consistent with the data. The model accounts for several pricing implications that are puzzling for a large class of theories. The good performance on the quantities side is maintained.

Using wholesale price data for common products sold in Canada and United States over the period 2004-6 and information on the country of production for individual products, Burstein and Jaimovich document new facts on international relative price movements. They find that international relative prices at the level of individual products are roughly three to four times as volatile as the Canada-U.S. nominal exchange rate at quarterly frequencies. Aggregate real exchange rates, constructed by averaging movements in international relative prices for individual goods, closely follow the appreciation of the Canadian dollar over this period. The large movements in international relative prices for traded goods are in conflict with the hypothesis of relative purchasing power parity, but point instead to the practice of pricing-to-market by exporters. In light of these findings, the authors construct a model of international trade and pricing to market that can account for the observed movements in product- and aggregate real-exchange rates for both traded and non-traded products.

Currency excess returns are highly predictable and strongly counter-cyclical. The average excess returns on low interest rate currencies are about 5 percent per annum smaller than those on high interest rate currencies after accounting for transaction costs. A single return-based factor, the return on the highest minus the return on the lowest interest rate currency portfolios, explains the cross-sectional variation in average currency excess returns from low- to high-interest-rate currencies. Lustig, Roussanov, and Verdelhan show that the high-minus-low currency return measures the component of the stochastic discount factor innovation that is common across countries.

Conventional wisdom suggests that financial liberalization can help countries insure against idiosyncratic risk. There is little evidence, however, that countries have increased risk sharing despite recent widespread financial liberalization. According to Bai and Zhang, the key to understanding this puzzling observation is that conventional wisdom assumes frictionless international financial markets, while actual international financial markets are far from frictionless. In particular, financial contracts are incomplete and enforceability of debt repayment is limited. Default risk of debt contracts constrains borrowing, and more importantly, it makes borrowing more difficult in bad times, precisely when countries need insurance the most. Thus, default risk of debt contracts hinders international risk sharing. When countries remove their official capital controls, default risk is still present as an implicit barrier to capital flow; the observed increase in capital flow under financial liberalization is in fact too limited to improve risk sharing. If default risk of debt contracts were eliminated, capital flow would be six times greater, and international risk sharing would increase substantially.

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Health Care

NBER's Program on Health Care met in Cambridge on November 12. Organizer Richard Frank, of Harvard Medical School and NBER, chose the following papers to discuss:

Ming Tai-Seale, Texas A&M University, and Tom McGuire, Harvard University, "Time is Up: The Increasing Shadow Price of Time in Primary Care Office Visits"

R.D. Cebul and Mark Votruba, Case Western Reserve University; James B. Rebitzer, Case Western Reserve University and NBER; and Lowell Taylor, Carnegie Mellon University, "Unhealthy Insurance Markets: Search Frictions and the Cost and Quality of Health Insurance" (NBER Working Paper No. 14455)

Jonathan Clark, Harvard University, and Robert Huckman, Harvard University and NBER, "Broadening Focus: Complementarities and the Benefits of Specialization in the Hospital Industry"

Claudio Lucarelli, Cornell University, and Sean Nicholson, Cornell University and NBER, "A Quality Adjusted Price Index for Colorectal Cancer Drugs"

Amy Finkestein and Daron Acemoglu, MIT and NBER, and Matt Notowidigdo, MIT, "Income and Health Spending: Evidence from Oil Price Shocks"

Guy David and Seth Richards, University of Pennsylvania, and Sara Markowitz, Emory University and NBER, "The Effects of Pharmaceutical Marketing and Promotion on Adverse Drug Events and Regulation"

A physician's time is a precious resource in primary care, and the physician must constantly evaluate the gain from spending more time with the current patient versus moving on to address the health care needs of the next one. Tai-Seale and McGuire formulate the physician's decision problem and characterize two rules for deciding about when to end a visit. The first rule, which is labeled "efficient," has the physician end a visit when the estimated value of more time falls below a shadow price. Following the second "behavioral" rule, the physician terminates a visit when "time is up" and a target number of minutes have expired. The authors test for the behavioral rule against the alternative using video recordings of 385 visits by elderly patients to their primary care physician. The researchers structure the data at the "topic" level and find evidence consistent with the behavioral rule. Specifically, time elapsed within a visit is a very strong determinant of whether the physician decides this is the "last topic" to be discussed, thereby effectively ending the visit. The authors consider whether dislodging a target-time mentality from physicians (and patients) might contribute to more productive primary care practice.

Health insurance is a complex product, which creates search frictions that can distort market outcomes. Cebul, Rebitzer, Taylor, and Votruba study the effect of frictions in the market for employer-based health insurance. They find that frictions are most severe in the "fully insured" part of the group health insurance market. They estimate that frictions in this market segment cause a quarter of the consumer surplus to shift from policy-holders to insurers (a transfer of $32.5 billion in 1997). Their analysis also suggests that frictions in insurance markets reduce incentives to invest in future health.

The literature on related diversification suggests that multi-unit firms with a portfolio of related businesses outperform both single-unit firms and multi-unit firms composed of unrelated businesses. Previous explanations for this relationship have centered on economies of scope achieved by sharing common resources, such as advertising, or production capacity. Clark and Huckman consider another potential explanation: complementarities, or the extent to which the marginal returns to the intensity of a focal activity increase with the intensity of related activities. Using patient-level data from the hospital industry, they consider the existence of complementarities with respect to focused organizational experience. Specifically, they investigate the extent to which there are returns to focused experience in cardiovascular care, and the degree to which these returns depend on a hospital's intensity of services that relate to cardiovascular care. The researchers find suggestive evidence of positive returns, average, to focused experience in cardiovascular care. Moreover, these returns are contingent on the intensity with which hospitals provide clinical services that are closely related to cardiovascular care.

The average price of providing a colorectal cancer patient with a 24-week chemotherapy regimen increased from $127 in 1993 to $36,300 in 2005, largely because of the approval and widespread use of five new drugs between 1996 and 2004. Lucarelli and Nicholson ask whether the substantial increase in spending has been worthwhile. They construct a price index for colorectal cancer drugs for each quarter between 1993 and 2005 that takes into account the quality (that is, the efficacy and side effects, as reported in clinical trials) of each drug on the market and the value that oncologists place on drug quality. They find that the naive price index, which does not adjust for the changing attributes of drugs on the market, greatly overstates the true price increase. Both the hedonic price index and a quality-adjusted price index show that prices have actually remained fairly constant over this 13-year period, with slight increases or decreases depending on the model's assumptions.

Health expenditures as a share of GDP have more than tripled over the last half century. A common conjecture is that this is primarily a consequence of rising real per capita income, which more than doubled over the same period. Acemoglu, Finkelstein, and Notowidigdo investigate this empirically by using the time-series variation in global oil prices between 1970 and 1990, interacted with cross-sectional variation in the oil reserves across different areas of the Southern United States, as instruments for local area income. This strategy enables them to capture both the partial equilibrium and the local general equilibrium effects of an increase in income on health expenditures. Their central estimate is an income elasticity of 0.7, with an elasticity of 1.1 as the upper end of the 95 percent confidence interval. Point estimates from alternative specifications fall on both sides of this central estimate, but are almost always less than 1. Consistent with their finding that health spending does not appear to be a luxury good, the authors do not find a significant effect of increased income on hospital technology adoption; this suggests that there are unlikely to be substantial global general equilibrium effects (which would not be estimated by their empirical strategy) of rising income on health spending via induced innovation. The overall reading of the evidence is that rising income is unlikely to be a major driver of the rising health share of GDP.

David, Markowitz, and Richards analyze the relationship between post-marketing promotional activity and the reporting of adverse drug events by modeling the interaction between a welfare maximizing regulator (the FDA) and a profit maximizing firm. In their analysis, demand is sensitive to both promotion and regulatory interventions. Promotion-driven market expansions enhance profitability, but may involve the risk that the drug would be prescribed inappropriately, leading to adverse regulatory actions against the firm. This model exposes the effects of the current regulatory system on consumer and producer welfare. Particularly, the emphasis on safety over benefits distorts the market allocation of drugs away from some of the most appropriate users. Using an innovative combination of commercial data on pharmaceutical promotion and FDA data on regulatory interventions and adverse drug reactions, the authors provide some evidence that increased levels of promotion and advertising lead to increased reporti adverse medical events for certain conditions.

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Higher Education

The NBER's Working Group on Higher Education met in Cambridge on November 13. The group's Director, Charles T. Clotfelter of NBER and Duke University, chose these papers to discuss:

Judith Scott-Clayton, Harvard University, "On Money and Motivation: A Quasi-Experimental Analysis of Financial Incentives for College Achievement"

Esteban Aucejo, Duke University; and Peter Arcidiacono and Hanming Fang, Duke University and NBER, "Does Affirmative Action Lead to Mismatch? A New Test and Evidence"(see page 51 of this issue)

Todd R Stinebrickner, University of Western Ontario and NBER, and Ralph Stinebrickner, Berea College, "Learning about Academic Ability and the College Drop-out Decision"

Thomas Dee, Swarthmore College and NBER, "Stereotype Threat and the Student-Athlete"

Bruce A. Weinberg, Ohio State University and NBER, "Scientific Leadership"

Ginger Zhe Jin, University of Maryland and NBER, and Alexander Whalley, University of California, Mercer, "The Power of Attention: Do Rankings Affect the Financial Resources of Public Colleges?" (NBER Working Paper No. 12941)

Programs that link substantial amounts of college financial aid to student achievement have proved increasingly popular in recent years. These programs could work either by relaxing financial constraints or by inducing additional student effort (or both). Scott-Clayton examines the PROMISE scholarship in West Virginia, which provides free tuition and fees to college students who maintain a minimum GPA and course load. Using an unusually comprehensive administrative database, she exploits discontinuities in both the eligibility formula and the timing of implementation to identify program effects. She finds robust and statistically significant effects on key academic outcomes, including a 6.7 percentage point increase in four-year BA completion rates among PROMISE recipients. These impacts are concentrated at the precise thresholds for annual scholarship renewal-particularly the minimum course load requirement-and disappear in the fourth year of college when students are still receiving the scholarship but no longer have the opportunity to renew. The findings suggest that the program works by establishing clear academic goals and incentives to meet them, rather than simply reducing the cost of college.

Although assumptions about how agents update subjective beliefs in response to the arrival of new information play a central role in models of decisionmaking, there is little empirical evidence to inform these assumptions. Stinebrickner and Stinebrickner use unique data to examine how college students from low-income families update their beliefs about academic ability and to examine the role that learning about ability, and a variety of other factors, play in the college drop-out decision.

The academic underperformance of student-athletes at selective colleges and universities has motivated ongoing concern about the role of athletics in these institutions. The growing literature on the effects of social identity suggests one possible explanation for this phenomenon. Student-athletes may experience a reduction in cognitive performance in evaluative settings like classrooms where they expect to be viewed through the lens of a negative stereotype. Dee presents an economic model of such a "stereotype threat" that reconciles prior evidence on how student effort and performance are influenced by this social-identity phenomenon; he also presents empirical evidence from a laboratory experiment in which student-participants were randomly assigned to a treatment that primed their awareness of an athletic identity. This treatment reduced the test-score performance of athletes relative to non-athletes by 14 percent (effect size = -1.0). However, this effect was largely concentrated among males and students with below-median SAT scores.

At the beginning of the twentieth century, Europe as a whole and Germany in particular dominated science. Today, the United States does. Using rich datasets on Nobel laureates in Chemistry, Medicine, and Physics, and highly cited publications, Weinberg shows that investments in science and a competitive market for science in the United States were the most important factors in the emergence of the United States as a scientific leader. In contrast to previous work, he finds here that scientists fleeing the Nazis played a relatively modest role. The evidence suggests that scientific leadership is more fluid than generally believed, highlighting the importance of investments in science and a competitive environment -- both as developing countries seek to build cutting-edge scientific communities, and as the United States and Europe seek to maintain their positions.

Jin and Whalley investigate whether and how college quality rankings affect a key factor in the ranks measure of quality -- financial resources per student -- for public colleges. They show that when a public college is exogenously included in the U.S. News & World Report rankings, educational and general expenditures per student increase by 3.2 percent. To fund the additional expenditure, state appropriations per student increase by 3.4 to 6.8 percent, while tuition is not responsive at all. The state appropriation response may be realized in two potential channels: on the one hand, U.S. News rankings may allocate additional citizen attention to the issue of public college quality, and the increased attention steers more funding towards public colleges. On the other hand, college rankings may provide new information in addition to existing college guides. As the college quality beliefs of citizens are updated state governments may adjust funding accordingly. The authors find evidence in supp explanation.

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Education Program Meets

The NBER's Program on Education met in Cambridge on November 14. Program Director Caroline M. Hoxby of NBER and Stanford University organized the meeting. These papers were discussed:

Richard J. Murnane, Harvard University and NBER, and Jennifer Steele and John Willett, Harvard University, "Do Financial Incentives Help Low-Performing Schools Attract and Keep Academically Talented Teachers? New Evidence from California"

Kirabo Jackson, Cornell University, "Student Demographics, Teacher Sorting, and Teacher Quality: Evidence from the End of School Desegregation"

Jonah E. Rockoff, Columbia University and NBER, and Lesley Turner, Columbia University, "Short-Run Impacts of Accountability on School Quality"

Hanley Chiang, Mathematica, Inc., "How Accountability Pressure on Failing Schools Affects Student Achievement"

Gauri Kartini Shastry, University of Virginia, "Human Capital Response to Globalization: Education and Information Technology in India"

Maria Fitzpatrick, Stanford University, "Preschoolers Enrolled and Mothers at Work? The Effects of Universal Pre-Kindergarten"

Fernando B. Botelho and Ricardo A. Madeira, University of Sao Paulo, and Marcos A. Rangel, University of Chicago, "Discrimination Goes to School? Understanding Racial Differences in Non-Blind Grading"

Murnane, Steele, and Willett capitalize on a natural experiment that occurred in California between 2000 and 2002: in those years, the state offered a competitively allocated $20,000 incentive, called the Governor's Teaching Fellowship (GTF), aimed at attracting academically talented, novice teachers to low-performing schools and retaining them in those schools for at least four years. Taking advantage of data on the career histories of 14,045 individuals who pursued California teaching licenses between 1998 and 2003, the authors are able to estimate the unbiased impact of the GTF on the decisions of recipients to begin and continue working in low-performing schools. They find that acquiring a GTF increased the probability that recipients entered low-performing schools within two years after licensure program enrollment by 34 percentage points. However, on average, GTF recipients left low performing schools at a higher rate in their first year of teaching than academically talented teachers chose to work in low-performing schools.

Jackson uses the reshuffling of students caused by the end of student busing in Charlotte-Mecklenburg to investigate the relationship between changes in student attributes and changes in teacher quality that are not confounded with changes in school or neighborhood characteristics. His results suggest that the spatial correlation between teachers' residences, students' residences, and schools could lead to spurious correlation between student attributes and teacher characteristics. Re-shuffling the students led to teacher resorting, so that schools that experienced a repatriation of black students also experienced a decrease in various measures of teacher quality (including estimated value-added). Jackson shows that this was primarily because of a labor supply response.

In November 2007, the New York City Department of Education assigned each elementary and middle school a letter grade (A to F) as part of a new accountability system. The grades were based on continuous numeric scores derived from levels and changes in student achievement and other school environmental factors such as attendance, and were linked to a system of rewards and consequences for schools and principals. Rockoff and Turner use the discontinuities in the assignment of school grades to estimate the short-run impact of accountability. Specifically, they examine student achievement in English Language Arts and mathematics (measured in January and March of 2008, respectively) using school-level aggregate data. Although schools had only a few months to respond to the release of accountability grades, receipt of a low grade significantly increased student achievement in both subjects, with larger effects in math. The authors find no evidence that accountability grades were related to the percentage of students tested, implying that accountability systems can cause real changes in school quality that increase student achievement over even a short time horizon. Parental evaluations of educational quality improved considerably for schools receiving low accountability grades; however, these schools also experienced a larger increase in survey response rates, holding open the possibility of selection bias in these complementary results.

Although an emerging body of evidence has shown that the threat of sanctions on low-performing schools can raise student test scores in the short run, the extent to which these test score improvements are attributable to schools' manipulation of the accountability system has remained uncertain. Chiang provides two new strands of evidence to evaluate the relative importance of educational reforms and gaming behavior in generating test score gains by threatened schools. First, using a methodology that exploits Florida's system of imposing sanction threats on the basis of a cutoff level of performance, the author estimates medium-run effects on student test scores from having attended a threatened elementary school. Threat-induced math improvements from elementary school largely persist at least through the first one to two years of middle school, while evidence for persistence of reading improvements is less consistent. Second, Chiang analyzes the effects of sanction threats on various features of educational production and finds that they increase school spending on instructional technology, curricular development, and teacher training. Both strands of evidence are consistent with a predominant role for educational reforms in generating test score gains by threatened schools.

Recent studies have shown that trade liberalization increases the skilled wage premium in developing countries. Thus globalization may benefit elite skilled workers relatively more than poor unskilled workers, increasing inequality. However, that effect may be mitigated if human capital investment responds to new global opportunities. One key question is whether a country with a more elastic human capital supply is better positioned to benefit from globalization. Shastry examines how the impact of globalization varies across Indian districts with different costs of skill acquisition, focusing on the cost of learning English, a relevant qualification for high-skilled export jobs. Linguistic diversity in India compels individuals to learn either English or Hindi as a lingua franca. Some districts have lower relative costs of learning English because of linguistic predispositions and psychic costs associated with past nationalistic pressure to adopt Hindi. Shastry demonstrates that districts with a more elastic supply of English skills benefited more from globalization: they experienced greater growth in both information technology jobs and school enrollment. Consistent with this human capital response, these districts experienced smaller increases in skilled wage premiums.

Three states recently introduced Universal Pre-Kindergarten programs offering free preschool to all age-eligible children; policymakers in many other states are promoting similar programs. Using restricted-access data from the Census, together with year and birthday-based eligibility cutoffs, Fitzpatrick estimates the effects of Universal Pre-K availability on overall preschool enrollment and maternal labor supply. She finds that Universal Pre-K availability increases statewide preschool enrollment by at least 14 percent but has little effect on the labor supply of most women. The exception is women residing in rural areas, whose probability of being employed increases by 20 percent.

Recent literature suggest that observed racial differentials in labor markets are the result of lower investment in the accumulation of skills, or of pre-market factors, by individuals of African descent. If parents and children update investment decisions after extracting signals about scholastic abilities from school reports, then differential errors in perceived ability could reinforce racial gaps in the accumulation of human capital. Botelho, Madeira, and Rangel present evidence drawn from a unique dataset of Brazilian elementary, middle, and high-schools suggesting that teachers' grading (when compared to blindly scored tests of proficiency) suffers from cardinal and ordinal biases associated with a child's race .

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Monetary Economics

The NBER's Program on Monetary Economics met in Cambridge on November 14. Organizers Ricardo Reis and Michael Woodford of NBER and Columbia University chose these papers to discuss:

Mark Bils , University of Rochester and NBER; Peter J. Klenow , Stanford University and NBER; and Benjamin A. Malin , Federal Reserve Board, "Reset Price Inflation and the Impact of Monetary Policy Shocks"
Discussant: Jon Steinsson, Columbia University and NBER

Thomas J. Sargent , New York University and NBER, and Paolo Surico , Bank of England, "Monetary Policies and Low-Frequency Manifestations of the Quantity Theory"
Discussant: James H. Stock, Harvard University and NBER

Olivier Coibion , College of William & Mary, and Yuriy Gorodnichenko , University of California, Berkeley and NBER, "What Can Survey Forecasts Tell Us about Informational Rigidities?"
Discussant: Justin Wolfers, University of Pennsylvania and NBER

Bernardo Guimaraes and Kevin D. Sheedy , London School of Economics, "Sales and Monetary Policy"
Discussant: Ariel Burstein, University of California, Los Angeles and NBER

George-Marios Angeletos , MIT and NBER, and Jennifer La'O , MIT, "Dispersed Information over the Business Cycle: Optimal Fiscal and Monetary Policy"
Discussant: Robert King, Boston University and NBER

Alejandro Justiniano , Federal Reserve Bank of Chicago, and Giorgio E. Primiceri , Northwestern University and NBER, "Potential and Natural Output"
Discussant: Christopher Erceg, Federal Reserve Board

A standard state-dependent pricing model generates little monetary non-neutrality. Two ways of generating more meaningful real effects are time-dependent pricing and strategic complementarities. These mechanisms have telltale implications for the persistence and volatility of "reset price inflation," which is the rate of change of all desired prices (including for goods that have not changed price in the current period). Using the micro data underpinning the CPI, Bils, Klenow, and Malin construct an empirical measure of reset price inflation. They find that time-dependent models imply unrealistically high persistence and stability of reset price inflation. This discrepancy is exacerbated by adding strategic complementarities, even under state-dependent pricing. A state-dependent model with no strategic complementarities aligns most closely with the data.

To detect the quantity theory of money, Sargent and Surico look at scatter plots of filtered time series of inflation and money growth rates and interest rates and money growth rates. They relate those scatter plots to sums of two-sided distributed lag coefficients constructed from fixed-coefficient and time-varying vector auto-regressions (VARs) for U.S. data from 1900-2005. They interpret outcomes in terms of population values of those sums of coefficients implied by two dynamic stochastic general equilibrium (DSGE) models. The DSGE models make the sums of coefficients depend on the monetary policy rule via cross-equation restrictions of a type that earlier authors, including Lucas and Sargent, emphasized in the context of testing the natural unemployment rate hypothesis. When the U.S. data are extended beyond Lucas's 1955-75 period, the patterns revealed by scatter plots mutate in ways that the authors want to attribute to prevailing monetary policy rules.

Coibion and Gorodnichenko use three different surveys of economic forecasts to assess both the support for and the properties of informational rigidities faced by agents. Specifically, they track the impulse responses of mean forecast errors and disagreement among agents after exogenous structural shocks. Their key contribution is to document that, in response to structural shocks, mean forecasts fail to completely adjust on impact, leading to statistically and economically significant deviations from the null of full information: the half life of forecast errors is roughly between six months and a year. Importantly, the dynamic process followed by forecast errors following structural shocks is consistent with the predictions of models of informational rigidities. The authors interpret this finding as providing support for the recent expansion of research into models of informational rigidities. In addition, they document several stylized facts about the conditional responses of forecast errors and disagreement among agents that can be used to differentiate between some of the models of informational rigidities recently proposed.

A striking fact about prices is the prevalence of "sales" -- large temporary price cuts followed by prices returning exactly to their former levels. Guimaraes and Sheedy build a macroeconomic model with a rationale for sales based on firms facing consumers with different price sensitivities. Even if firms can adjust sales without cost, monetary policy has large real effects owing to sales being strategic substitutes: a firm's incentive to have a sale is decreasing in the number of other firms having sales. Thus the flexibility seen in individual prices attributable to sales does not translate into flexibility of the aggregate price level.

Angeletos and La'O study how the heterogeneity of information affects the efficiency of the business cycle and the design of optimal fiscal and monetary policy. They do so within a model that features a standard Dixit-Stiglitz demand structure, introduces dispersed private information about the underlying aggregate productivity shock, and allows this information to be imperfectly aggregated through certain prices and macroeconomic indicators. Their key findings are: 1) when information is exogenous to the agents' actions, the response of the economy to either fundamentals or noise is efficient along the flexible-price equilibrium; 2) the endogeneity of learning renders the business cycle inefficient: there is too little learning and too much noise in the business cycle; 3) both state-contingent taxes and monetary policy can boost learning over the business cycle; 4) typically, this implies that the optimal tax is countercyclical, while the optimal monetary policy is less accommodative than what is consi with replicating the flexible-price equilibrium; and 5) even if monetary policy were to replicate the flexible-price equilibrium, this would not mean targeting price stability. Rather, the optimal monetary policy has the nominal interest rate increase, and the price level fall, in response to a positive innovation in productivity.

Justiniano and Primiceri estimate a DSGE model with imperfectly competitive products and labor markets and sticky prices and wages. They use the model to back out two counterfactual objects: potential output -- that is, the level of output that would prevail under perfect competition; and natural output -- that is, the level of output that would prevail with flexible prices and wages. They find that potential output is smooth, which results in an output gap that closely resembles traditional measures of de-trended output. Meanwhile natural output is extremely volatile, because of the very high variability of markup shocks. These disturbances, however, are very similar to measurement errors because they only explain price and wage inflation at very high frequencies. Under this alternative interpretation, potential and natural output move one-to-one.

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Asset Pricing

NBER's Program on Asset Pricing met on November 21 in Cambridge. Organizers Monika Piazzesi, Stanford University and NBER, and Stijn Van Nieuwerburgh, New York University and NBER, chose the following papers to discuss:

Eric Swanson and Glenn Rudebusch, Federal Reserve Bank of San Francisco, "The Bond Premium in a DSGE Model with Long-Run Real and Nominal Risks"
Discussant: Stanley E. Zin, Carnegie Mellon University and NBER

Itamar Drechsler, University of Pennsylvania, and Amir Yaron, University of Pennsylvania and NBER, "What's Vol Got to Do With It?"
Discussant: Lars P. Hansen, University of Chicago and NBER

Akub Jurek, Princeton University, "Crash-Neutral Currency Carry Trades"
Discussant: Adrian Verdelhan, Boston University

Santiago Bazdrech and Frederico Belo, University of Minnesota, and Xiaoji Lin, London School of Economics, "Labor Hiring, Investment, and Stock Return Predictability in the Cross Section"
Discussant: Francois Gourio, Boston University

Martijn Cremers and Antti Petajisto, Yale University, and Eric Zitzewitz, Dartmouth College, "Should Benchmark Indices Have Alpha? Revisiting Performance Evaluation"
Discussant: Lubos Pastor, University of Chicago and NBER

John Y. Campbell and Luis M. Viceira, Harvard University and NBER, and Adi Sunderam, Harvard University, "Inflation Bets or Deflation Hedges? The Changing Risks of Nominal Bonds"
Discussant: George Tauchen, Duke University

The term premium on nominal long-term bonds in the standard dynamic stochastic general equilibrium (DSGE) model used in macroeconomics is far too small and stable relative to empirical measures obtained from the data -- an example of the "bond premium puzzle." However, in models of endowment economies, researchers have been able to generate reasonable term premiums by assuming that investors have recursive Epstein-Zin preferences and face long-run economic risks. Rudebusch and Swanson show that introducing Epstein-Zin preferences into a canonical DSGE model can also produce a large and variable term premium without compromising the model's ability to fit key macroeconomic variables. Long-run real and nominal risks further improve the model's ability to fit the data with a lower level of household risk aversion.

Uncertainty plays a key role in economics, finance, and decision sciences. Financial markets, and in particular derivative markets, provide fertile ground for understanding how perceptions of economic uncertainty and cash-flow risk manifest themselves in asset prices. Drechsler and Yaron demonstrate that the variance premium, defined as the difference between the squared VIX index and expected realized variance, captures attitudes toward uncertainty. The authors present conditions under which the variance premium displays significant time variation and return predictability. A calibrated, generalized Long-Run Risks model generates a variance premium with time variation and return predictability that is consistent with the data, while simultaneously matching the levels and volatilities of the market return and risk free rate. The evidence indicates an important role for transient non-Gaussian shocks to fundamentals that affect agents' views of economic uncertainty and prices.

Currency carry trades implemented within G10 currencies have historically delivered significant excess returns with annualized Sharpe ratios in excess of one. Jurek investigates whether these excess returns reflect compensation for exposure to crash risk by analyzing the time-series dynamics of the moments of the risk-neutral distribution extracted from currency options, and by examining returns to crash-neutral currency carry trades in which exposure to crashes has been hedged by combining positions in currencies and currency options. Risk-neutral and realized skewness move in opposite directions in response to realized currency returns, Jurek shows, such that insurance against currency crashes is cheapest precisely when it is needed most. Although excess returns to crash-neutral strategies decline relative to their unhedged counterparts, they remain positive and highly statistically significant. These results indicate that crash risk premiums can explain 30-40 percent of the total excess return to currency carry trades. Rationalizing all of the excess return via a crash risk premium would require implied volatilities of out-of-the-money currency options to be roughly four times greater than those observed in the data.

Bazdrech, Belo, and Lin show that the firm-level hiring rate predicts stock returns in the cross-section of U.S. publicly traded firms, even after controlling for investment, size, book-to-market, and momentum, as well as other known predictors of stock returns. The predictability shows up in both Fama-MacBeth cross-sectional regressions and in portfolio sorts and it is robust to the exclusion of microcap firms from the sample. The authors propose a production-based asset pricing model with adjustment costs in labor and capital that replicates well the main empirical findings. Labor adjustment costs make hiring decisions forward looking in nature and thus informative about the firms' expectations about future cash-flows and risk-adjusted discount rates. The model implies that the investment rate and the hiring rate predicts stock returns because these variables proxy for the firm's time-varying conditional beta.

Standard Fama-French and Carhart models produce economically and statistically significant nonzero alphas even for passive benchmark indexes, such as the S&P 500 and the Russell 2000. Cremers, Petajisto, and Zitzewitz find that these alphas primarily arise from the disproportionate weight the Fama-French factors place on small value stocks that have performed well, and from the CRSP value-weighted market index that is a downward-biased benchmark for U.S. stocks. The authors explore alternative ways to construct these factors and propose alternative models constructed from common and easily tradable benchmark indexes. Such index-based models outperform the standard models, in terms of both asset pricing tests and performance evaluation of mutual fund managers.

The covariance between U.S. Treasury bond returns and stock returns has moved considerably over time. While it was slightly positive on average in the period 1953- 2005, it was particularly high in the early 1980s and negative in the early 2000s. Campbell, Sunderam, and Viciera specify and estimate a model in which the nominal term structure of interest rates is driven by five state variables: the real interest rate, risk aversion, temporary and permanent components of expected inflation, and the covariance between nominal variables and the real economy. The last of these state variables enables the model to fit the changing covariance of bond and stock returns. Log nominal bond yields and term premiums are quadratic in these state variables, with term premiums determined mainly by the product of risk aversion and the nominal-real covariance. The concavity of the yield curve -- the level of intermediate-term bond yields, relative to the average of short- and long-term bond yields -- is a good proxy for the level of term premiums. The nominal-real covariance has declined since the early 1980s, driving down term premiums.

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Behavioral Finance

The NBER's Behavioral Finance group met on November 22 in Cambridge. Brad Barber, University of California, Davis, and Terrance Odean, Hass School of Business at Berkeley, organized the meeting. These papers were discussed:

Camelia M. Kuhnen and Agnieszka Tymula, Northwestern University, "Rank Expectations, Feedback, and Social Hierarchies"
Discussant: Shimon Kogan, University of Texas, Austin

Han Ozsoylev, University of Oxford, and Johan Walden, University of California, Berkeley, "Asset Pricing in Large Information Networks"
Discussant: Xavier Gabaix, New York University and NBER

Nicola Gennaioli, CREI, and Andrei Shleifer, Harvard University and NBER, "Local Thinking"
Discussant: Drazen Prelec, MIT

Roger M. Edelen, University of California, Davis; Richard Evans, University of Virginia; and Gregory B. Kadlec, Virginia Tech, "What Do Soft-Dollars Buy? Performance, Expense Shifting, Agency Costs"
Discussant: Lori Walsh, Securities and Exchange Commission

Randy Cohen, Harvard University; and Christopher Polk and Bernard Silli, London School of Economics, "Best Ideas"
Discussant: Clemens Sialm, University of Texas, Austin and NBER

Harrison Hong, Princeton University, and Leonard Kostovetsky, University of Rochester, "Red and Blue Investing: Values and Finance"
Discussant: Raymond Fisman, Columbia University and NBER

Kuhnen and Tymula develop and test a theoretical model of the role of self-esteem -- generated by private feedback regarding relative performance -- on the behavior of agents working on a simple task for a flat wage. The authors isolate the impact on one's output of learning one's rank in the group as opposed to the effect of any reputation, strategy-updating, or peer-monitoring effects. Feedback has both ex-ante and ex-post effects on the productivity of workers and on the dynamics of social hierarchies. Agents work harder and expect to rank better when they are told they may learn their ranking, relative to cases when they are told that feedback will not be provided. After receiving feedback, individuals who learn that they have ranked better than expected decrease their output, but they expect an even better rank in the future; those told they ranked worse than expected will increase their output and at the same time lower their expectations of rank going forward. These effects are stronge rounds of the task, while subjects learn how they compare to their peers. This rank hierarchy is established early on, and remains relatively stable afterwards. Private relative rank information helps create a ratcheting effect in the group's average output, which is mainly attributable to the fight for dominance at the top of the hierarchy. These results suggest that in environments where monetary incentives are weak, moral hazard can be mitigated by providing feedback to agents regarding their relative performance, and by optimally choosing the reference peer group. Therefore, social hierarchy effects on productivity may influence optimal team formation.

Kogan, Ozsoylev, and Walden study asset pricing in economies with large information networks. They derive closed-form expressions for price, volatility, profitability, and several other key variables, as a function of the topological structure of the network. The authors focus on networks that are sparse and have power-law degree distributions, in line with empirical studies of large scale human networks. This makes it possible to rank information networks along several dimensions and to derive several novel results. For example, price volatility is a non-monotonic function of network connectedness, as is average expected profits. Moreover, the profit distribution among investors is intimately linked to the properties of the information network. The authors also examine which networks are stable, in the sense that no agent has an incentive to change the network structure. They show that if agents are ex ante identical, then strong conditions are needed to allow for non-degenerate net including power-law distributed networks. If, on the other hand, agents face different costs of forming links, which are interpreted broadly as differences in social skills, then power-law distributed networks arise quite naturally.

Gennaioli and Shleifer present a theory of judgment under uncertainty based on the idea that individuals evaluate hypotheses by filling in missing data (called frames) from their memory. The researchers assume that the frames that come to mind first are those most predictive of the hypothesis being evaluated relative to its alternatives. Combining this view of frames with the assumption of limited memory yields a theory of decisionmaking that accounts for many representativeness-related findings of Kahneman and Tversky, including the Linda experiment.

Edelen, Evans, and Kadlec examine several hypotheses regarding mutual-fund commission payments. Consistent with an information motive, they find, relatively active funds pay higher excess commissions and these "soft dollar" payments are associated with improved return performance. However, excess commissions are also related to an expense-shifting motive and these payments are associated with lower return performance -- suggesting that agency costs arise from soft-dollar payments. The strongest evidence for expense shifting occurs with relatively controversial distribution expenses, and these payments exhibit the most severe performance degradation (agency costs). Overall, the impact of soft dollar payments on performance is negative.

Cohen, Polk, and Silli provide powerful evidence that mutual fund managers can pick stocks that outperform the market. They examine the performance of stocks that represent managers' "Best Ideas" and find that the stock that active managers display the most conviction towards ex-ante outperforms the market, and the other stocks in those managers' portfolios, by approximately 39 to 127 basis points per month depending on the benchmark employed. This suggests two conclusions. First, the U.S. stock market does not appear to be efficiently priced, because even the typical active mutual fund manager is able to identify a stock that outperforms. Second, the organization of the money management industry appears to make it optimal for managers to introduce stocks into their portfolio that are not outperformers, even though they are able to pick good stocks.

Do political values influence investing? Hong and Kostovetsky answer this question using data on the political contributions and stock holdings of U.S. investment managers. They find that mutual fund managers who make campaign donations to Democrats hold less of their portfolios (relative to non-donors or Republican donors) in industries that are deemed socially irresponsible (for example tobacco, guns, defense, and natural resources). Although a higher fraction of Democrat-run mutual funds are socially responsible (SRI), this result holds for non-SRI funds and after controlling for other fund and manager characteristics. The effect is more than one-half of the under-weighting observed for SRI funds. Furthermore, the authors find that Democrat managers also tilt towards firms with positive social features, such as excellent employee relations and clean environmental records. They document similar results among a smaller sample of hedge fund managers, suggesting that lax corporate governance in the m fund industry is not the main driver of their results. Finally, they discuss how political values influence investing and the implications of their findings for the growing SRI movement and stock prices.

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Corporate Finance

The NBER's Corporate Finance Program met on November 21 in Cambridge. Organizers Holger Mueller, NBER and New York University, and Joshua Rauh, NBER and University of Chicago, chose these papers to discuss:

Martijn Cremers, Yale University, and Yaniv Grinstein, Cornell University, "The Market for CEO Talent: Implications for CEO Compensation"
Discussant: Xavier Gabaix, New York University and NBER

C. Fritz Foley, Harvard University and NBER; Dhammika Dharmapala, University of Connecticut; and Kristin Forbes, MIT and NBER, "The Unintended Consequences of the Homeland Investment Act: Implications for Financial Constraints, Governance, and International Tax Policy"
Discussant: Heitor Almeida, University of Illinois and NBER

Viral Acharya, New York University; Raghuram Rajan, University of Chicago and NBER, and Stewart C. Myers, MIT and NBER, "The Internal Governance of Firms"
Discussant: Jeremy C. Stein, Harvard University and NBER

Josh Lerner, Harvard University and NBER, and Ulrike Malmendier, University of California, Berkeley and NBER, "With a Little Help from My (Random) Friends: Success and Failure in Post-Business School Entrepreneurship"
Discussant: Simon Johnson, MIT and NBER

Philippe Aghion, Harvard University and NBER; John Van Reenen, London School of Economics and NBER; and Luigi Zingales, University of Chicago and NBER, "Innovation and Institutional Ownership"
Discussant: David S. Scharfstein, Harvard University and NBER

Todd Gormley, Washington University in St. Louis, and David Matsa, Northwestern University, "Growing Out of Trouble? Legal Liability and Corporate Responses to Adversity"
Discussant: Antoinette Schoar, MIT and NBER

Gerard Hoberg, University of Maryland, and Gordon M. Phillips, University of Maryland and NBER, "Product Market Synergies and Competition in Mergers and Acquisitions"
Discussant: Paul Tetlock, Columbia University

Cremers and Grinstein study the market for CEO talent in public U.S. corporations from 1993-2005. They find large fragmentation of CEO talent pools. In particular, about 68 percent of new CEOs are former employees of their own firm ("insider CEOs") and 86 percent are former employees in firms belonging to the same industry (including insider CEOs). Talent pool structure explains several compensation practices: CEO compensation is only benchmarked against other firms, and pay-for-luck is prevalent only when the industry has a small percentage of insider CEOs. Finally, the authors study the importance of talent pools. Finding little support when incorporating the fragmentation of CEO talent pools, they offer a reinterpretation of the Gabaix-Landier results.

The Homeland Investment Act of 2004 provided for a one-time tax holiday on the repatriation of foreign earnings, thereby allowing U.S. multinationals to access earnings retained abroad at a lower cost. Firms responded to this act by significantly increasing repatriations from foreign affiliates. Dharmapala, Foley, and Forbes analyze the impact of the tax holiday on firm behavior. They find that repatriations did not lead to an increase in investment, employment, or R and D -- even for the firms that lobbied for the tax holiday stating these intentions. Instead, a $1 increase in repatriations was associated with an increase of approximately $1 in payouts to shareholders. These responses are consistent with the view that the domestic operations of U.S. multinationals were not financially constrained and that U.S. multinationals are reasonably well-governed. The results also have significant implications for understanding the impact of the U.S. corporate tax system on the behavior of multinational firms.

Acharya, Myers, and Rajan develop a model of internal governance where the self-serving actions of top management are limited by the potential reaction of subordinates. The authors find that internal governance can mitigate agency problems and ensure firms have substantial value, even without any external governance. Internal governance seems to work best when both top management and subordinates are important to value creation. The authors then allow for governance provided by external financiers and find situations where external governance, even if crude and uninformed, complements internal governance in improving efficiency. Interestingly, this allows the development of a theory of dividend policy, where dividends are paid by self-interested CEOs to maintain a balance between internal and external control. Finally, the authors explore how the internal organization of firms may be structured to enhance the role of internal governance. Young firms with limited external oversight, an with poor external governance, can have substantial value, and improving external governance may not be a panacea for all governance problems.

A central question in the entrepreneurship literature is how to encourage entrepreneurship and whether peers affect the decision to become an entrepreneur. Lerner and Malmendier exploit the fact that Harvard Business School assigns students into sections, which have varying representation of former entrepreneurs. They find that the presence of entrepreneurial peers strongly predicts subsequent entrepreneurship rates of their peers who did not have an entrepreneurial background, but in a more complex way than the literature has previously suggested. A higher share of students with an entrepreneurial background in a given section leads to their peers to lower rather than higher subsequent rates of entrepreneurship. However, the decrease in entrepreneurship is entirely driven by a reduction in unsuccessful entrepreneurial ventures. The relationship between the shares of pre-HBS and successful post-HBS peer entrepreneurs is insignificantly positive. Sections with few prior entrepreneurs have a considerably higher variance in their rates of unsuccessful entrepreneurs. The authors argue that these results are consistent with intra-section learning, where the close ties between section-mates lead to insights about the merits of business plans.

Aghion, Van Reenen, and Zingales find that institutional ownership in publicly traded companies is associated with more innovation (measured as cited-weighted patents), even after they control for possible endogeneity of institutional ownership. To explore the mechanism through which this link arises, the authors build a model that nests managerial laziness with career-concern considerations, where institutional ownership increases the incentives managers have to innovate by reducing the career risk of innovative projects. While the lazy-manager hypothesis predicts a substitution effect between institutional ownership and product market competition, the career-concern hypothesis allows for complementarity. The effect of institutional investors on innovation increases with product market competition, supporting the career-concern model. This model is also supported by the authors' finding that that CEOs are less likely to be fired in the face of profit downturns when institutional ownership is higher.

Gormley and Matsa measure how a typical firm responds when a chemical to which its workers are exposed is newly identified to be a carcinogen. While there is no evidence of a pre-existing trend, the authors find that firms, particularly those more vulnerable to the realization of an adverse shock, tend to undertake aggressive growth and increased acquisitions after experiencing the liability shock. The acquisitions appear to be targeted at diversifying the firms' assets by acquiring large businesses with relatively high operating cash flows, recent growth, and total payouts. These deals are associated with high takeover premiums and negative abnormal returns. These findings are broadly inconsistent with the perfect capital markets model, but fit well with an agency model where managers have career concerns. In support of the agency model, the authors find that total assets grow most among firms with weak external governance, high management ownership, or low institutional ownership, whereas f external governance, low management ownership, or high institutional ownership instead increase their payouts to shareholders. These results suggest that agency conflicts may be exacerbated when firms are closer to financial distress.

Hoberg and Phillips examine how product similarity and competition influences mergers and acquisitions and the ability of firms to exploit product market synergies. Using novel text-based analysis of firm 10K product descriptions, they find three key results: 1) Firms are more likely to enter restructuring transactions when the language describing their assets is similar to all other firms, consistent with their assets being more re-deployable. 2) Targets earn lower announcement returns when similar alternative target firms exist. 3) Acquiring firms in competitive product markets experience increased profitability, higher sales growth, and increased changes in their product descriptions when they buy target firms that are similar to them and different from rival firms. The authors' findings are consistent with similar merging firms exploiting synergies to create new products and increase their product differentiation relative to ex-ante rivals.

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