recursive equilibria in dynamic economies with stochastic production in this paper we prove the existence of recursive equilibria in stochastic production economies with infinitely lived agents and incomplete financial markets we consider a general dynamic model with several commodities which encompasses heterogeneous agent versions of both the lucas asset pricing model and the stochastic neo classical growth model as special cases our main assumption is that there are atomless shocks to fundamentals that have a purely transitory component and a component that does not depend on last period s shocks directly

the asset pricing effects of fixed holding costs an upper bound the capital asset pricing model predicts that investors will hold diversified portfolios but many households actually hold very few assets the paper examines the asset pricing implications of one possible explanation for this phenomenon fixed costs of holding assets while earlier authors found the exact asset pricing effects of such costs in single period models under restrictive assumptions i derive a general upper bound on these effects that is also valid in continuous time illustrative calculations reveal that large holding costs must be postulated to generate significant asset pricing effects

prices and investment with collateral and default abstract this paper uses the framework of an olg economy with three period lived agents in which a durable good serves as collateral for loans to study the effect of an unanticipated income shock when the economy is in a steady state equilibrium we focus on the consequence of default on loans when the value of the collateral falls below the value of the debt it secures we analyze the impulse response functions of the price and production of the durable good and show that there is an asymmetry between the response of the price and investment of the durable good to a positive and a negative income shock arising from default on the collateralized loans we show that this asymmetry can be seen in the data on housing prices and construction and is attributable to the default on mortgages in periods of decreasing prices which acts as a turbo mechanism magnifying the decline in investment

secular cost changes and the size of government towards a generalized theory abstract baumol s cost disease account of government growth is contrasted with that of kau and rubin who focus on decreasing costs of tax collection over time the apparent paradox wherein the first theory explains government growth by cost increases and the second by way of cost decreases is technically resolved why both theories seem to be able to stand up to empirical tests even though they use similar data is then explained finally public choice analysis is employed to reveal further potential for the ultimate construction of one all embracing secular cost change theory of government growth

international financial integration and crisis contagion international financial integration helps to diversify risk but also may spread crises across countries we provide a quantitative analysis of this trade off in a two country general equilibrium model with collateral constrained borrowing using a global solution method borrowing constraints bind occasionally depending upon the state of the economy and levels of inherited debt we examine different degrees of international financial integration moving from financial autarky to bond and equity market integration financial integration leads to a significant increase in global leverage substantially escalates the probability of crises for any one country and dramatically increases the degree of contagion across countries outside of crises the impact of financial integration on macroeconomic aggregates is relatively small but the impact of a crisis with integrated international financial markets is much less severe than that under financial market autarky thus a trade off emerges between the probability of crises and the severity of crises using a large cross country database of financial crises in developing and developed economies over a forty year period we find evidence in support of the model

taxes and transaction costs in asset market equilibrium abstract this paper examines the effects of capital taxation in an imperfect capital market in which acquiring risky assets incurs costs individual portfolio choice has two distinct aspects the extensive choice of which assets to hold in the portfolio and the intensive choice of what fraction of wealth to invest in each asset held the traditional assumption of zero transaction costs obscures the extensive choice this paper shows that if trading in assets is costly capital taxes have extensive effects as well as the intensive effects previously studied

wealth and portfolio composition theory and evidence we examine a survey of 6010 u s households and estimate a model for household portfolio allocation we extend the conventional portfolio choice model in order to capture the observed incompleteness of household portfolios we show that the empirical specification of the joint discrete and continuous choice that characterizes household portfolio behavior is a switching regressions model with endogenous switching we go on to examine the impact of taxes on portfolio composition using detailed survey data to calculate precisely the marginal tax rate facing each household finally we estimate wealth elasticities of demand for a range of assets and liabilities

securitized markets international capital flows and global welfare we study the effect of collateralized lending and securitization on the global supply of securitized assets welfare and international net and gross capital flows in a two country general equilibrium model with idiosyncratic investment risk the financial sectors in the two countries home and foreign differ by the collateral requirement for investment loans with home requiring lower margins in autarky home endogenously supplies more assets and enables more risk sharing upon financial integration capital flows from foreign to home leading to lower interest rates and an increase in the global supply of assets foreign enjoys substantial welfare gains through better risk sharing and portfolio reallocation while the welfare experience for home is ambiguous gross capital flows arise when agents face aggregate shocks to the expected payoff to investment projects but can collapse when shocks concern the variance of returns

collateral avoids ponzi schemes in incomplete markets without introducing either debt constraints or transversality conditions to avoid the possibility of ponzi schemes we show the existence of equilibrium in an infinite horizon incomplete markets economy with a collateral structure

approximate versus exact equilibria in dynamic economies this paper develops theoretical foundations for an error analysis of approximate equilibria in dynamic stochastic general equilibrium models with heterogeneous agents and incomplete financial markets while there are several algorithms that compute prices and allocations for which agents first order conditions are approximately satisfied approximate equilibria there are few results on h interpret the errors in these candidate solutions and how to relate the computed allocations and prices to exact equilibrium allocations and prices we give a simple example to illustrate that approximate equilibria might be very far from exact equilibria we then interpret approximate equilibria as equilibria for close by economies that is for economies with close by individual endowments and preferences

real government size automatic feedback rules and the measured effectiveness of fiscal policy this paper argues that as intervention fiscal policy means more than simply any change in government spending and this requires of fiscal analysis a measure that separates the allocative from the counter cyclical activities of government defining intervention as an optimal policy rule that responds automatically to privately unanticipated variations in output a general equilibrium model is built to separate the supply side effects of desired changes in the size of government from demand side interventions designed to stimulate aggregate demand the model is tested using the results of a public choice investigation of the real size of government ferris and west 1996 that exercise produces a measure of desired size and through its residual an implicit measure of intervention the paper tests the prediction that increases in desired size increase aggregate supply and that ex post measures of fiscal intervention can be recovered and tested for their effect on aggregate output the test uses citibase

escape dynamics in learning models this article illustrates and characterizes how adaptive learning can lead to recurrent large fluctuations learning models have typically focused on the convergence of beliefs towards an equilibrium however in stochastic environments there may be rare but recurrent episodes where shocks cause beliefs to escape from the equilibrium generating large movements in observed outcomes i characterize the escape dynamics by drawing on the theory of large deviations developing new results which make this theory directly applicable in a class of learning models the likelihood frequency and most likely direction of escapes are all characterized by a deterministic control problem i illustrate my results with two simple examples

a damped diffusion framework for financial modeling and closed form maximum likelihood estimation abstract asset price bubbles can arise unintentionally when one uses continuous time diffusion processes to model financial quantities we propose a flexible damped diffusion framework that is able to break many types of bubbles and preserve the martingale pricing approach damping can be done on either the diffusion or drift function oftentimes certain solutions to the valuation pde can be ruled out by requiring the solution to be a limit of martingale prices for damped diffusion models monte carlo study shows that with finite time series length maximum likelihood estimation often fails to detect the damped diffusion function while fabricates nonlinear drift function an alternative method based on ait sahalia s specification test on parametric models is proposed

financial intermediation house prices and the welfare effects of the u s great recession abstract this paper quantifies the welfare costs of the great recession in the united states and their distribution between borrowing and saving households we use a calibrated dynamic general equilibrium model with shocks to aggregate income and to the financial intermediation sector the model matches the boom bust cycle in house prices the dynamics of household leverage and the increase in inequality of wealth observed in the u s after 2007 we find large welfare costs for financially constrained households the borrowers savers instead benefited from a redistribution of housing wealth due to the de leveraging of borrowers caused by the plunge in house prices this redistribution mechanism was exacerbated by the financial intermediation shock we also show that the welfare costs for borrowers would have been lower if aggregate leverage had remained at pre 2001 levels

some additional results on investment risk taking and full loss offset corporate taxation with interest deductibility it is argued that a full loss offset corporate tax with interest deductibility may reduce risk taking in that entrepreneurs might decrease the amount of investment made in risky projects with higher corporate tax rates unlike previous results in the literature production functions with decreasing returns to scale and the possibility of equity financing of capital investment are allowed a corporate tax that falls in part on the returns of equity owners or entrepreneurs can under certain conditions reduce risk taking if the government taxes only risk then a corporate tax with a full loss offset can encourage investment in risky projects

fairness price stickiness and history dependence in decentralized trade this chapter investigates the implications that social preferences have for the stationary strategic equilibrium of such a decentralized market agents are supposed to be averse to unfairly unfavorable as well as unfairly favorable deals in the spirit of fehr and schmidt 1999 but we stay rather close to standard individualistic preferences the negative weights on advantageous and disadvantageous deviations from what is considered as the fair benchmark are such that utility remains strictly increasing in own surplus share and in contrast to the original fehr schmidt model the fair split need not automatically be a 50 50 division any price between sellers cost and buyers willingness to pay may be the one which for whatever reasons is agents reference point in a given market this makes it possible to consider a more flexible notion of fairness than is usually done it is in line with cognitive dissonance theory from psychology and the noteworthy experiments of binmore et al 1991 1993 where subjects who were triggered to play different bargaining equilibria ended up considering very different surplus distributions as fair

portfolio manager behavior and global financial crises abstract i develop a two market agent based model to study how global portfolio managers affect global financial crises and stability first i create an agent based model where fund managers make their allocation decisions between two markets and a risk free asset based on the mean variance framework simulation results reveal that global managers do not create global financial crises second i extend the base model by incorporating insights from behavioral finance where risk is instead determined by fund manager losses simulation results reveal that slight global manager losses can trigger a widening of both markets risk premium accelerating the decline in asset prices worldwide statistical analysis reveals that global managers are a stabilizing force in smaller numbers however they become destabilizing in larger numbers the ability to reduce risk by diversifying across markets results in excessive risk taking if global managers exist in larger numbers systematic over leverage may result such that a deleveraging process can lead to the spreading of financial crises

regulating collateral requirements when markets are incomplete in this paper we examine the eects of default and collateral on risk sharing we assume that there is a large set of assets which all promise a risk less payo but which distinguish themselves by their collateral requirements in equilibrium agents default the assets have dierent payos and there are as many linearly independent assets available for trade as there are states of the world we derive necessary and sucient conditions for equilibria to be pareto ecient in the presence of uncertainty we explore some examples for which the collateral equilibrium allocation is identical to the arrow debreu allocation either when agents have a high preference for the durable good or when the endowment distribution of the durable good is relatively homogeneous we examine a series of examples to understand which collateral levels prevail in equilibrium and under which conditions there is scope for regulating margin requirements that is restricting the sets of tradable assets through government intervention in these examples equilibrium is always sub optimal but regulation never leads to a pareto improvement while the competitive equilibria are constrained ecient there do exist regulations which make large

cost disease versus leviathan explanations of rising government cost an empirical investigation in this paper we reexamine the apparently conflicting empirics of borcherding et al 1977 versus those of barry and lowery 1984 the latter designed to test the cost disease versus bureau voting power hypotheses on us citibase annual data between 1947 to 1979 was retested for the longer period available through 1989 second and more importantly we isolate and test for the presence of a second channel for the exercise of bureaucratic power that channel is the bureau s ability to use its information advantage to capture a portion of newly generated government rents through higher personal benefits such as higher salaries such an analysis following west 1991 requires first that those factors generating new rents for government actually result in successful bureaucratic rent seeking in the form of higher compensation levels in addition the analysis requires that these artificial increases in bureaucratic wages show up as significant determinants of the higher cost of providing government services incorporating a constructed kau rubin variable into the barry and lowery database is then shown to improve the predictive power of both the cost disease and bureaucratic power hypotheses for us annual data between 1948 and 1989

do institutions promote rationality an experimental study of the three door anomaly the three door problem is an example of a systematic violation of a key rationality postulate that has attracted much attention in this seemingly simple individual decision task most people initially fail to apply correctly bayes law and to make the payoff maximizing choice previous experimental studies have shown that individual learning reduces the incidence of irrational choices somewhat but is far from eliminating it we experimentally study the roles of communication and competition as institutions to mitigate the choice anomaly we show that the three door anomaly can be entirely eliminated by these institutions

costly search and mutual fund flows this paper studies the flows of funds into and out of equity mutual funds consumers base their fund purchase decisions on prior performance information but do so asymmetrically investing disproportionately more in funds that performed very well the prior period search costs seem to be an important determinant of fund flows high performance appears to be most salient for funds that exert higher marketing effort as measured by higher fees flows are directly related to the size of the fund s complex as well as the current media attention received by the fund which lower consumers search costs

testing theories of real government size u s experience 1959 89 in a recent article west 17 argued that the existence of so many strands of analysis attempting to explain the growth of government calls ultimately for one consolidated or generalized theory accordingly he produced a model that integrated four such theories two on the cost side and two on the demand side the purpose of the present paper is to derive empirical measures of all four theories using u s data for the period 1959 1989 the presumption is that each one separately might contribute in its own way to a composite explanation of government growth and that what is currently most needed is a set of jointly determined empirical estimates showing relative importance while all our measures of government size consolidate federal state and local government expenditures two other measurement issues should be emphasized since they distinguish our work from other contributions to this literature the government component of our main dependent variable the real size of government is measured in two different ways the first uses the national accounts definition of government purchases which excludes transfer payments from the measure of size whereas the second includes final purchases plus net government transfer payments since we are interested in the effects of changes in the productivity of supplying government services the first of these definitions is expected to be more relevant and is so used as the basis of our empirical work however since there is a sense in which changes in the productivity of government may affect the output of transfers we also use the second definition to produce a more complete empirical exercise the other distinguishing feature of our analysis is that both definitions of government size are analyzed in real as distinct from the more usual nominal share of government in gross domestic product gdp this distinction becomes immediately more striking when it is pointed out that while most authors hitherto have attempted to explain the phenomenon of positive growth in the ratio of nominals over the past half century the ratio of reals has actually fallen for most of our

health care education and the cost disease a looming crisis for public choice an economic specter haunts the democratic governments of the world s most prosperous economies the rising cost of health care and education casts a shadow over virtually every election while increasing costs of other services play a part in the growth of the homeless population and the deteriorating sanitation of city streets it will be shown here that both an explanation and a solution in principle are available however while the solution is in one sense simple and straightforward in another it poses a problem of frightening magnitude for public choice if the citizens of these countries are willing to do what is necessary for the supply of educational health care and other related services to keep up with the expansion in overall economic output made possible by rising productivity then if my analysis is correct a difficult choice will be required either ever more of gross national product will have to be channeled through the public sector with all the problems we know that to entail or alternatively these services will have to be transferred to private enterprise in fields where private business firms can hope to succeed only if granted an improbably immunity from the temptation of unwise governmental interference this is indeed scylla and charybdis in spades

the method of endogenous gridpoints with occasionally binding constraints among endogenous variables we show how the method of endogenous gridpoints can be extended to solve models with occasionally binding constraints among endogenous variables very efficiently we present the method for a consumer problem with occasionally binding collateral constraints and non separable utility in durable and non durable consumption this problem allows for a joint analysis of durable and non durable consumption in models with uninsurable income risk which is important to understand patterns of consumption saving and collateralized debt we illustrate the algorithm and its efficiency by calibrating the model to us data

a two period model with portfolio choice understanding results from different solution methods using a stylized two period model we compare portfolio solutions from two local solution approaches the approach of judd and guu 2001 and the approach of devereux and sutherland 2010 2011 with the true nonlinear portfolio solution

wealth dynamics in a bond economy with heterogeneous beliefs two types of agents have diverse beliefs about the law of motion for an exogenous endowment one knows the true process and the other learns about it via bayes theorem financial market structure affects the dynamics of the wealth distribution when markets are complete the learning agent loses wealth as in blume and easley 2006 the absence of markets for some arrow securities alters the direction in which wealth is transferred when the only traded asset is a risk free bond the learning agent accumulates wealth both agents survive and the more knowledgeable agent is driven to his debt limit

collateral requirements and asset prices many assets derive their value not only from future cash flows but also from their ability to serve as collateral in this article we investigate this collateral premium and its impact on asset returns in an infinite horizon general equilibrium model with heterogeneous agents we document that borrowing against collateral substantially increases the return volatility of long lived assets moreover otherwise identical assets with different degrees of collateralizability exhibit substantially different return dynamics because their prices contain a sizable collateral premium that varies over time this premium can be positive even for assets that never pay dividends

a bound testing analysis of wagner s law in nigeria 1970 2006 this study tests wagner s law the tendency for government activities to expand along with economic expansion for nigeria using annual time series data between 1970 and 2006 it adopts the bounds test approach proposed by pesaran et al 2001 based on unrestricted error correction model uecm and toda and yamamoto s 1995 granger noncausality tests empirical results from the bounds test indicate that there exists no long run relationship between government expenditure and output in nigeria in addition toda and yamamoto s 1995 causality test results show that wagner s law does not hold for more than the period being tested rather we found a weak empirical support in the proposition by keynes that public expenditure is an exogenous factor and a policy instrument for increasing national income

does foreign aid promote the expansion of government building on the literature on public finance i seek to advance our understanding of variations in government size by exploring the impact of official development assistance on fiscal policy i hypothesize that foreign aid operates in accordance with the flypaper effect systematically generating incentives and opportunities for the expansion of government spending results from a time series cross sectional regression analysis of growth in government spending over the 1970 99 time period are consistent with the hypothesis for middle and lower income nations aid represents an important determinant of government expansion looking at the tax and revenue side of the equation however reveals a more perverse pattern of response aid promotes not only increased spending but also reduced revenue generation the results have important implications from both a theoretical and policy perspective inter alia they point to the potentially self defeating nature of efforts to promote market oriented programs of state retrenchment via development assistance as well as to the importance of incorporating international transfers into future research on government spending

saving accounts versus stocks and bonds in household portfolio allocation we study the structure of household portfolios of financial wealth by analyzing both the determinants of total financial wealth and the choice between risky stocks and bonds and riskfree assets saving accounts the econometric specification is a generalized trivariate tobit model estimated on a cross section of 3 077 households in the netherlands in 1988 we account for endogeneity of financial wealth and for selectivity due to nonreporting results show that the level of financial wealth and the marginal tax rate are major determinants of the allocation between riskfree and risky assets

international portfolios a comparison of solution methods we compare the performance of the perturbation based local portfolio solution method of devereux sutherland 2010a 2011 with a global solution method as a test suite we use model specifications that broadly capture features of international financial trade between advanced economies and between advanced and emerging economies we consider both symmetric country setups and asymmetric setups that capture important empirical facts such as differences in macroeconomic volatility differences in portfolio composition and high equity premia we find that the local method performs well at business cycle frequencies both in the symmetric and asymmetric settings while significant differences arise at long horizons in asymmetric settings

the causes of government expenditure growth a survey of the u s evidence abstract the growth of government budgets can be broken down into a institutional and institutional components the former component the familiar substitution income and population public goods tax sharing effects is estimated to contribute about two fifths of the growth of u s government spending the latter component rent seeking political redistributions bureaucracy and perceptual informational impedimentia is important too but an exact imputation cannot be asserted given the state of the art in empirical public choice theory the cross effects on spending of the growth of regulation and tax preferences or tax expenditures though interesting is not pursued

international capital flows portfolio composition and the stability of external imbalances abstract this paper develops a simple and tractable model of net capital flows in which time varying gross country portfolios are an essential element in current account imbalances the main constituents of country portfolios in the model are general derivatives which could be interpreted as nominal bond assets and liabilities in particular under very weak conditions the world wealth distribution is stationary stationarity is generated by movements in derivative i e bond risk premia such that the return on a debtor country s gross liabilities is less than the return on its gross assets this is well known feature of the us international investment position we also provide suggestive evidence that a similar property holds more widely for a sample of advanced and emerging market countries

bubbles and crashes gradient dynamics in financial markets abstract fund managers respond to the payoff gradient by continuously adjusting leverage in our analytic and simulation models the base model has a stable equilibrium with classic properties however bubbles and crashes occur in extended models incorporating an endogenous market risk premium based on investors historical losses and constant gain learning when losses have been small for a long time asset prices inflate as fund managers increase leverage then slight losses can trigger a crash as a widening risk premium accelerates deleveraging and asset price declines

endogenous leverage and asset pricing in double auctions abstract we propose a double auction mechanism for the exchange of leveraged assets and bonds in an agent based model in this framework we validate recent results in general equilibrium theory about endogenous leverage and its consequences for asset pricing we find that the institutional details of exchange are critical for a good match between the theoretical equilibrium state and the final state of the double auction specifically the outcome of the double auction is sensitive to the details of how markets for debt and collateral are coordinated and how collateral is cleared when trade is restricted to neighbours in a network final prices and allocations are significantly different from unrestricted equilibrium

tax evasion and the marginal cost of public funds tax evasion and deadweight loss have similar implications for the rules of public finance the optimal mix of taxes can be derived from the minimization of the sum of aggregate deadweight loss and aggregate cost of tax evasion similarly the marginal cost of public funds includes allowances for marginal deadweight loss and marginal cost of tax evasion per dollar of public revenue acquired

market simulation and the provision of public goods a non paternalistic response to anomalies in environmental evaluation most normative economics assumes that individuals have coherent preferences this paper responds to growing evidence of failures of this assumption particularly in the context of stated preference methods widely used in environmental policy analysis it proposes a non paternalistic concept of consumer sovereignty that does not assume preference coherence is satisfied by competitive markets and can be applied to the provision of public goods a key implication is that decisions should reflect valuations revealed at the point of consumption such valuations which can be inferred from hedonic prices may be less susceptible to willingness to accept wta willingness to pay wtp disparities than those elicited by stated preference methods

on the optimal tax base for commodity taxation taxed considerable effort has been devoted to characterizing the manner in which the optimal tax rates differ across the taxable commodities but the literature has rarely addressed the issue of which commodities should be included in the tax base in fact the standard optimal tax model cannot provide a useful answer to this question because it does not contain any of the resource costs normally associated with the collection of taxes an omission that seriously diminishes the policy relevance of the model 2

a case for incomplete markets we propose a new welfare criterion that allows us to rank alternative financial market structures in the presence of belief heterogeneity we analyze economies with complete and incomplete financial markets and or restricted trading possibilities in the form of borrowing limits or transaction costs we describe circumstances under which various restrictions on financial markets are desirable according to our welfare criterion

dynamic competitive economies with complete markets and collateral constraints in this article we examine the competitive equilibria of a dynamic stochastic economy with complete markets and collateral constraints we show that provided the sets of asset pay offs and of collateral levels are sufficiently rich the equilibrium allocations with sequential trades and collateral constraints are equivalent to those obtained in arrow debreu markets subject to a series of limited pledgeability constraints we provide both necessary and sufficient conditions for equilibria to be pareto efficient and show that when collateral is scarce equilibria are not only pareto inefficient but also often constrained inefficient in the sense that imposing tighter borrowing restrictions can make everybody in the economy better off we derive sufficient conditions for the existence of markov equilibria and for the case of two agents for the existence of equilibria that have finite support these equilibria can be computed with arbitrary accuracy and the model is very tractable

arbitrage with fixed costs and interest rate models in this paper we study securities market models with fixed costs we characterize the absence of arbitrage opportunities and we provide fair pricing rules we then apply these results to extend some popular interest rate and option pricing models which present arbitrage opportunities in the absence of fixed costs in particular we prove that the quite striking result obtained by dybvig ingersoll and ross 1996 which asserts that under the assumption of absence of arbitrage long zero coupon rates can never fall is no longer true in models with fixed costs even arbitrarily small ones for instance models where the long term rate follows a diffusion process are arbitrage free in the presence of fixed costs including arbitrarily small ones we also rationalize models with partially absorbing or reflecting barriers on the price processes in particular we propose a version of the cox ingersoll and ross 1985 model which as in longstaff 1992 produces yield curves with realistic humps but does not assume an absorbing barrier for the short term rate this is made possible by the presence of even arbitrarily small fixed costs

conspicuous consumption dynamics abstract we formalize veblen s idea of conspicuous consumption as two alternative forms of interdependent preferences dubbed envy and pride agents adjust consumption patterns gradually in the direction of increasing utility from an arbitrary initial state the distribution of consumption among agents with identical preferences converges to a unique equilibrium distribution when pride is stronger the equilibrium distribution has a right skewed density when envy is stronger the equilibrium is concentrated at a single point and the adjustment dynamics involve a shock wave that can be interpreted as a growing moving homogeneous middle class

escaping nash inflation an ordinary differential equation ode gives the mean dynamics that govern the convergence to self confirming equilibria of self referential systems under discounted least squares learning another ode governs escape dynamics that recurrently propel away from a self confirming equilibrium in a model with a unique self confirming equilibrium the escape dynamics make the government discover too strong a version of the natural rate hypothesis the escape route dynamics cause recurrent outcomes close to the ramsey commitment inflation rate in a model with an adaptive government

fiscal decentralization and the size of government a european country empirical analysis this article is an original contribution to the understanding of the relationship between fiscal decentralization and government size using a panel data set of the eu 15 countries we analyse the effect of decentralization on aggregate national and subnational government sizes by separating the long run effects of decentralization from its short run dynamics in the long run tax autonomy reduces central expenditure but increases and to a greater extent subnational public expenditure leading to higher aggregate public expenditure we find also that vertical imbalances tend to increase the sizes of subnational national and aggregate governments

portfolio and welfare consequences of debt market dominance the ability to issue debt that pays in units of the domestic good leads a country to accumulate a large and negative net foreign asset position while maintaining a positive position in equity this debt market advantage also helps to explain the weak relationship between the real exchange rate and relative consumption our stylized model matches the key facts about the u s international portfolio the u s real exchange rate and explains nearly 50 of the observed variation in the valuation effects we find that taxing bond market transactions increases the volatility of the exchange rate capital flows and allocations in contrast taxing equity positions stabilizes the exchange rate and capital flows while having little impact on the allocation lastly the paper describes a global solution method for portfolio problems under incomplete markets

on the internal revenue service s service and enforcement i introduction the internal revenue service irs services as well as audits taxpayers the irs provides taxpayer service through a variety of channels including its website toll free telephone lines and the taxpayer assistance center for fy 2008 the irs budget request includes 3 6 billion for taxpayer service and 7 2 billion for enforcement everson 2007 in the assessment of the fy 2009 irs budget request the government accountability office gao 2008 1 points out that effective tax administration requires a balance of service and enforcement and enforcement efforts should be combined with taxpayer service because both affect compliance although taxpayer service is an important activity of the irs s operation to our knowledge there is no formal model to address the connection between service and enforcement and more importantly its policy implications in the context of tax compliance this article seeks to take a step to fill this void we consider a simple tax compliance model which is built upon the seminal work of graetz reinganum and wilde 1986 hereafter grw unlike the classical contribution of allingham and sandmo 1972 and yitzhaki 1974 which treats the irs actions as exogenous in their analysis of tax evasion the grw model views the irs as a strategic player that interacts with taxpayers the grw model also differs from the principal agent tax evasion model first introduced by reinganum and wilde 1985 as pointed out by grw the principal agent model suffers from the time inconsistency problem as it requires that the irs announce and commit to an audit policy even though the precommitted audit policy will typically prove suboptimal once taxpayers submit their reported income grw emphasize that their interactive model follows the natural temporal sequence of decisions first taxpayers report their income and only then does the irs decide whether to perform tax audits this sequence is what we typically observe in the real world 1 however like other models on tax compliance grw consider the enforcement part but leave out the service part of the irs activities we extend the grw model to the real world in which the irs services as well as audits taxpayers similar to grw we assume that a taxpayer has either high income or low income to incorporate the role of the irs s service we also assume that taxpayers are uncertain about whether their incomes are eligible for deduction exemption and may seek advice from the taxpayer service provided by the irs to mitigate the uncertainty an important feature of our model is that in equilibrium all net tax revenues collected by the irs are from those taxpayers who voluntarily report high incomes to the irs to maximize the population of the taxpayers in this group the irs will not provide the most accurate service but only maintain an intermediate level of quality the optimal level of accuracy will be increasing as the difficulty in identifying the true income eligibility increases which may be due to more complicated tax laws moreover there exists a conflict between the irs and the society with regard to the optimal taxpayer service in that the society s preferred quality of taxpayer service is likely to be sufficiently high the conflict tends to be intensified as the cost of tax audits becomes lower our result is consistent with the trend in the united states regarding the resources allocated to the taxpayer service in the past few decades we also extend our model in the following two directions the first extension is to address the issue of corruption in tax administration many developing countries suffer from inefficiencies in tax administration and corruption arising from enforcement some authors argue that it is important for developing countries to recognize the service paradigm of tax compliance which emphasizes not only the role of enforcement but also the role of taxpayer service

financial integration and growth in a risky world abstract we revisit the debate on the benefits of financial integration in a two country neoclassical growth model with aggregate uncertainty the framework accounts simultaneously for gains from a more efficient capital allocation and gains from risk sharing together with their interaction global numerical methods allow for meaningful welfare comparisons gains from integration are quantitatively small even for riskier and capital scarce emerging economies these countries import capital for efficiency reasons before exporting it for self insurance leading to capital flows and growth reversals along the transition this opens the door to richer empirical implications than previously considered in the literature

the size of government most research on the causes of growth in government expenditure has focused on the demand for government services in this paper we argue that in fact this growth may have occurred because of changes in supply changes in technology leading to increased specialization and thus increased opportunity costs of self production have led to increased market production and increased record keeping also female labor force participation has increased both of these factors serve to reduce the efficiency cost of collecting taxes if the demand for government spending has not changed this increase in supply would lead to a larger public sector we estimate a system of simultaneous equations for the period 1929 1970 incorporating this hypothesis and the results are consistent with the theory we are able to explain virtually all of the growth of government increases in female labor force participation seems to be a very important variable in this explanation

margin regulation and volatility an infinite horizon asset pricing model with heterogeneous agents and collateral constraints can explain why adjustments in stock market margins under us regulation t had an economically insignificant impact on market volatility in the model raising the margin requirement for one asset class may barely affect its volatility if investors have access to another unregulated class of collateralizable assets through spillovers however the volatility of the other asset class may substantially decrease a very strong dampening effect on all assets return volatilities can be achieved by a countercyclical regulation of all markets

marginal taxes and the asset portfolios of swedish households this paper focuses on the effects of marginal tax rates wealth income and a set of socioeconomic and demographic variables on the portfolio composition of households using detailed micro data on 2 000 swedish households in particular efforts are made to disentangle the effects of marginal tax rates on the portfolio behavior of households some econometric problems involved when estimating asset demand equations in the presence of incomplete portfolios are briefly discussed a final section examines the overall effect of marginal tax rates on asset demands by applying estimated discrete and continuous portfolio equations to compute different tax elasticities

the power to tax analytical foundations of a fiscal constitution preface 1 taxation in constitutional perspective 2 natural government a model of leviathan 3 constraints on base and rate structure 4 the taxation of commodities 5 taxation through time income taxes capital taxes and public debt 6 money creation and taxation 7 the disposition of public revenues 8 the domain of politics 9 open economy federalism and taxing authority 10 toward authentic tax reform prospects and prescriptions epilogue notes selected bibliography index

price formation in double auctions abstract we develop a model of information processing and strategy choice for participants in a double auction sellers in this model form beliefs that an offer will be accepted by some buyer similarly buyers form beliefs that a bid will be accepted these beliefs are formed on the basis of observed market data including frequencies of asks bids accepted asks and accepted bids then traders choose an action that maximizes their own expected surplus the trading activity resulting from these beliefs and strategies is sufficient to achieve transaction prices at competitive equilibrium and complete market efficiency after several periods of trading journal of economic literatureclassification numbers d41 d44 d8

allocation of track capacity experimental evidence on the use of priority auctioning in the railway industry allocation of track capacity concerns multiple users facing demand indivisibilities running trains over an inelastic supply of railway tracks the paper suggests a vickrey type mechanism to handle incentive aspects of this technically complex optimisation task here the price for operating a train will correspond to the bids foregone by other operators who are pushed off their preferred routes the paper reports the results of 11 experimental markets using variations of this mechanism where each market includes up to 10 trading periods and subjects bid for routes over a highly stylised railway network the experiments generated solutions that capture 90 100 of potential benefits

phasing out the gses we develop a new model of the mortgage market where both borrowers and lenders can default risk tolerant savers act as intermediaries between risk averse depositors and impatient borrowers the government plays a crucial role by providing both mortgage guarantees and deposit insurance underpriced government mortgage guarantees lead to more and riskier mortgage originations as well as to high financial sector leverage mortgage crises occasionally turn into financial crises and government bailouts due to the fragility of the intermediaries balance sheets increasing the price of the mortgage guarantee crowds in the private sector reduces financial fragility leads to fewer but safer mortgages lowers house prices and raises mortgage and risk free interest rates due to a more robust financial sector consumption smoothing improves and aggregate welfare increases while borrowers are nearly indifferent to a world with or without mortgage guarantees savers are substantially better off while aggregate welfare increases so does wealth inequality jel g12 g15 f31

statistical arbitrage with default and collateral abstract this paper studies the implications of the absence of statistical arbitrage opportunities in a two period incomplete market economy where default is allowed but there are collateral requirements modified versions of the fundamental theorem of asset pricing are obtained

collateral constraints and asset prices abstract we study the effects of collateral constraints in an economy populated by investors with nonpledgeable labor incomes and heterogeneous preferences and beliefs we show that these constraints inflate stock prices and generate spikes and crashes in price dividend ratios and volatilities clustering of volatilities and leverage cycles they also lead to substantial decreases in interest rates and increases in sharpe ratios when investors are anxious about hitting constraints due to production crises in the economy furthermore stock prices have large collateral premiums over nonpledgeable incomes we derive asset prices and stationary distributions of the investors consumption shares in closed form

a unified beta pricing theory abstract this paper derives ross s mutual fund separation theory and a new equilibrium version of ross s arbitrage pricing theory as special cases of a general theory the paper also reveals that the two theories are identical in their predictions of asset prices and portfolio returns the capital asset pricing model a restricted case of the mutual fund separation theory receives special treatment

taxation portfolio choice and debt equity ratios a general equilibrium model this paper explores the portfolio behavior of investors differing with respect to both tax rates and risk aversion emphasizing the role of constraints on individual and firm behavior in ensuring the existence of and characterizing portfolio equilibrium under certain conditions on the securities available in the market which also are necessary for shareholders to be unanimous in supporting firm value maximization investors will be segmented by tax rate into two groups one specialized in equity and the other in debt though the relative wealths of the two groups determine the aggregate debt equity ratio each firm will be indifferent to its financial policy

collateral once again abstract this paper shows how collateral is used to prove the second part of the fundamental theorem of asset pricing in a collateral default setting which connects the concept of an arbitrage free price with the solution of the individual utility maximization problem

a test of the modigliani miller invariance theorem and arbitrage in experimental asset markets modigliani and miller show that the total market value of a firm is unaffected by a repackaging of asset return streams to equity and debt if pricing is arbitrage free we investigate this invariance theorem in experimental asset markets finding value invariance for assets of identical risks when returns are perfectly correlated however exploiting price discrepancies has risk when returns have the same expected value but are uncorrelated in which case the law of one price is violated discrepancies shrink in consecutive markets but persist even with experienced traders in markets where overall trader acuity is high assets trade closer to parity

allocative efficiency of markets with zero intelligence traders market as a partial substitute for individual rationality we report market experiments in which human traders are replaced by zero intelligence programs that submit random bids and offers imposing a budget constraint i e not permitting traders to sell below their costs or buy above their values is sufficient to raise the allocative efficiency of these auctions close to 100 percent allocative efficiency of a double auction derives largely from its structure independent of traders motivation intelligence or learning adam smith s invisible hand may be more powerful than some may have thought it can generate aggregate rationality not only from individual rationality but also from individual irrationality

studying the role of political competition in the evolution of government size over long horizons here we argue for the use of cointegration and error correction analysis to combine economic factors that are nonstationary with political factors that are stationary into an empirical model of the evolution of public policy over long periods the approach is applied to disentangle the contributions of economics and politics to the evolution of public expenditure by the government of canada over 130 years political competition emerges as the primary political factor affecting government size

asset shortages liquidity and speculative bubbles abstract we study the effect of asset shortages on liquidity in economies with limited enforcement of debt contracts we establish that under a suitable assumption in terms of gains from trade liquidity does not dry up and trading volumes do not disappear as credit conditions worsen the equilibrium outcome becomes arbitrarily close to a purely speculative equilibrium and bubbles occur in the limit the result applies to incomplete markets and more generally to equilibria where collateral constraints interfere with the additivity of the payoff pricing functional

trending economic factors and the structure of congress in the growth of government 1930 2002 we investigate the role of congress in the growth of federal public expenditure since 1930 building on the work of kau and rubin public choice 113 389 402 2002 the model incorporates majority party strength and the extent of party control of congress in addition to the median ideological position of elected representatives we first provide estimates of the relative importance of the state of congress and of trending supply and demand side economic factors in the evolution of federal spending the resulting models are then used to simulate the consequences of the radical and historically unprecedented shift to the right of congress in 1994 95

stationary equilibria in asset pricing models with incomplete markets and collateral we consider an infinite horizon exchange economy with incomplete markets and collateral constraints as in the two period model of geanakoplos and zame 2002 households can default on their liabilities at any time and financial securities are only traded if the promises associated with these securities are backed by collateral we examine an economy with a single perishable consumption good where the only collateral available consists of productive assets in this model competitive equilibria always exist and we show that under the assumption that all exogenous variables follow a markov chain there also exist stationary equilibria these equilibria can be characterized by a mapping from the exogenous shock and the current distribution of financial wealth to prices and portfolio choices we develop an algorithm to approximate this mapping numerically and discuss ways to implement the algorithm in practice a computational example demonstrates the performance of the algorithm and shows some quantitative features of equilibria in a model with collateral and default

taxation and household portfolio composition us evidence from the 1980s and 1990s abstract this paper explores the relationship between household marginal income tax rates the set of financial assets that households own and the portfolio shares accounted for by each of these assets it analyzes data from the 1983 1989 1992 1995 and 1998 surveys of consumer finances and develops a new algorithm for imputing federal marginal tax rates to households in these surveys the empirical findings suggest that marginal tax rates have important effects on asset allocation decisions the probability that a household owns tax advantaged assets such as tax exempt bonds or assets held in tax deferred accounts is positively related to its tax rate on ordinary income in addition the portfolio share invested in corporate stock which is taxed less heavily than interest bearing assets is increasing in the household s ordinary income tax rate holdings of heavily taxed assets such as interest bearing accounts decline as a share of wealth as a household s marginal tax rate increases

where have all the union members gone this paper examines trends in union membership during the twentieth century the hypothesis is advanced that the provision of certain social welfare benefits by government substitutes for the private provision by unions thereby reducing the attractiveness of union membership the empirical implications of this hypothesis are examined using time series data on aggregate union membership for the period 1904 80 and using pooled state data for the period 1964 80 these latter data are used to examine the effect of departures from the traditional doctrine of employment at will both the time series and the cross section evidence suggest that government supply of union like services reduces union membership

market clearing and price formation abstract considered here is decentralized exchange of privately owned commodity bundles voluntary transactions take the form of repeated bilateral barters under broad and reasonable hypotheses the resulting process converges to competitive equilibrium price taking behavior is not assumed prices emerge over time they need neither be anticipated nor known at any interim stage