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Economics Working Papers, 1994


"Evolution and the Dynamic Preference Specification."

Abstract: Arbitrariness is a problem in the selection of a dynamic utility representation. We adopt a fundamental approach to selecting among alternative dynamic utility specifications though postulating a rational basis for the goals. We propose that the principle of survival of the fittest should shape which utility functions are selected. If a longer survival time allows an individual to foster a greater number of offspring, evolutionary forces will lead to maximization of average survival time. Using this hypothesis we derive a non-time-separable expected utility representation that provides a natural framework for addressing life-cycle choices. We find that the rate of time preference depends endogenously on the aging process and wealth. Individuals become more myopic as wealth or health deteriorate. As a result a natural poverty line occurs below which a cycle of poverty arises and individuals become risk seeking out of desperation. Even as individuals become risk seeking in terms of consumption they remain risk averse in terms of wealth.


"Expected-Utility-Consistent Mean-Variance Preference Functions with "Perverse" Derivatives," published in Atlantic Economic Journal, December 1995.


"Dollar-Cost Averaging and Age Effects in Efficient Portfolio Plans."

Abstract: This paper considers the question of whether optimal inter-temporal portfolio plans conform to the common advice that risky assets should be bought gradually and then held in decreasing amounts as the investment horizon approaches. Under certain conditions, including as elliptic returns distribution, optimal open-loop portfolio plans must be mean-variance efficient. Then, for ARMA (1,1) parameterizations with negatively autocorrelated risky rates of return, the age effect (gradual diminishing of the risky asset holdings as the horizon approaches) is confirmed. In these cases the dollar-cost averaging effect (gradual entry into the risky asset) is confirmed for sufficiently distant horizons.

94-04 MITCHELL, DOUGLAS W. and Gregory M. Gelles

"Preference Functions Based on Expected Value and `Riskiness'."

Abstract: This paper demonstrates a method for characterizing choice under uncertainty by using the intuitive notion that agents care about the mean and "riskiness" of final wealth, as an alternative to the expected utility approach. The measure of riskiness is agent-specific, and is always increased by a mean-preserving spread. First-order stochastically dominating shifts are always preferred. The behavior of absolute and relative risk aversion is discussed, and several results in the expected utility literature are shown also to hold in the present context. This approach can be more tractable than the expected utility approach; two examples of enhanced tractability are provided.


"Mean-Variance Efficiency and Free Disposal."

Abstract: Ehrbar (1990,1993) showed that with no risk-free asset, not all points on the rising branch of the conventional mean-standard deviation boundary are efficient, because not all wealth need be invested. This implies the effective existence of a disposal asset with risk-free return of zero, so the true mean-standard deviation boundary has a linear segment form the origin, tangent to the conventional boundary. This paper shows that all (none) of the points on this linear segment are expected utility efficient if and only if there exists no (some) combination of assets with return guaranteed to be nonnegative

94-06 BALVERS, RONALD J. and Jeffrey Bergstrand.

"Intertemporal Substitution, Intratemporal Substitution and Equilibrium Real Exchange Rates."

Abstract: This paper generates closed-form theoretical solutions for the relationships among the real exchange rate, relative per capita consumption, and relative non-tradables productivity shocks in a stochastic dynamic general equilibrium model of two countries' representative consumers. The solutions offer insight into the robust cross-sectional relationship between relative per capita GDPs and relative national price levels established in Kravis and Lipsey (1983, 1987, 1988) in a manner consistent with equilibrium exchange rare theories and the productivity-differentials model of Balassa (1964) and Samuelson (1964). Application of panel data from Summers and Heston (1988) to the model's structural equations yields economically-plausible estimates of the elasticity of intertemporal substitution, the relative importance of non-tradables in consumption, and the rate of time preference in Europe relative to that in the United States.


"Monopoly Union or Efficient Contract: Does Corporatism Matter?"

Abstract: This paper studies the effects of corporatism on national welfare and optimal trade policy under two different models of wage and employment determination. In particular, the efficient contract model and the monopoly union model have been analyzed. We find that the results are remarkably different for the two models considered. Under free trade, corporatism is welfare augmenting in the monopoly union case while it has no effect on welfare in the efficient contract case. Under optimal trade intervention, the optimal subsidy is increasing in the degree of corporatism, with efficient contracting. Under monopoly unionism, however, the wage, employment and the optimal subsidy are independent of the degree of corporatism.

94-08 Zheng, Buhong, BRIAN CUSHING, and Victor Chow.

Tests of changes in the U.S. poverty level from 1975 to 1990, Regional Research Paper 9303.

Abstract: In this paper, we apply newly developed distribution-sensitive, decomposable poverty measures and methods of statistical inference to examine poverty changes in the U.S. from 1975 to 1989, disaggregated by gender and race. We also let the poverty line vary over a certain income range rather than using a single, arguable poverty line. While agreeing on the general poverty trend, the official poverty measures and distribution-sensitive measures present different pattern in the timing and duration of fluctuation in the poverty level. The numerical comparisons successfully rank order less than half of the year-to year-changes in the overall poverty. In contrast, the statistical procedure is able to rank order all year-to-year and period comparisons. This paper show that the combined use of distribution-sensitive measures, multiple poverty line and statistical inference yields much more robust conclusions about poverty than the official poverty statistics.


"Exchange Rate Evidence on the Effectiveness of U.N. Policy."

Abstract: This paper analyzes the effectiveness of U.N. interventions through their impact on exchange rates. The general implication is that if a specific U. N. intervention increases (decreases) the country's economic and political stability, then their currency should appreciate (depreciate). Estimates suggest that the peacekeeping forces in Lebanon caused long-run appreciations, while the economic sanctions imposed upon South Africa only caused temporary depreciations. In both the Lebanese and South African case, it appears that repeated U. N. Security Council resolutions condemning or demanding or demanding actions, that are not backed by actual U.N. intervention, do not cause changes in the exchange rate.

94-10 SOBEL, RUSSELL S. and Randall G. Holcombe.

"The Impact of State Rainy Day Funds in Easing State Fiscal Crises during the 1990-1991 Recession."

Abstract: Forty-four states have some type of rainy day fund intended to ease fiscal stress during revenue downturns. Most contained insufficient balances to eliminate the fiscal stress during the 1990-91 recession. To completely mitigate the effects of that recession, the typical state would have needed a surplus fund balance equal to about 30 percent of its 1988 budget, which was about ten times larger than the amount states actually had. In comparing provisions among states, the most important provision for the success of a rainy day fund is a legal requirement that money be deposited into the fund.

94-11 SOBEL, RUSSELL S. and Randall G. Holcombe.

"Measuring the Income Elasticity of Tax Bases Over the Business Cycle."

Abstract: The income elasticity of taxes is frequently used as an indicator of both short-run variability and long-run growth. This paper shows that the standard method for estimating elasticities results in asymptotic bias and inconsistent standard errors. Additionally, the standard estimates only provide information about the long-run growth potential of the tax. Thus, it is possible for a tax with a small estimated elasticity of fluctuate highly over the business cycle. This paper uses time-series econometric techniques to provide unbiased estimates of the long-run growth potential (the long-run elasticity) and cyclical variability (the short-run elasticity) of all major state tax bases

94-12 SOBEL, RUSSELL S. and Robert A. Lawson.

"Intrastate Differences in Representative and Senator Behavior: The Relative Impact of District Elections, Ideology, and Shirking."

94-13 PARK, EUN-SOO.

"Incentive Contracting under Limited Liability," published in Journal of Economics and Management Strategy.

Abstract: We examine the nature of incentive schemes between the principal and the risk-neutral agent in the presence of the agent's limited liability and ex-ante action choice. We consider alternative schemes when a simple rental contract is infeasible due to the limited liability of the agent and study the effectiveness of a performance bonus scheme in achieving the first-best outcome. We also discuss some implications of such schemes in real practices.

94-14 PARK, EUN-SOO.

"Incomplete Information in Bargaining Games."

Abstract: This paper studies a finite-horizon simultaneous-offer bilateral bargaining game in which one player might be of a crazy type who irrationally insists on some particular allocation. It is shown that if this player insists on this allocation, then the bargaining game will end within the first few rounds and he can get an expected payoff dose to that allocation. More importantly, the upper bound within which the bargaining game ends does not depend on the relative strength of the two players.


"Dynamic Duopolistic Competition with Sticky Prices: A Re-examination."

Abstract: We reexamine Fershtman and Kamien's (1990) differential game model of finite-horizon duopolistic competition with sticky prices. We present a complete characterization of the feedback Nash equilibrium of the model. We also show the turnpike properties of the equilibrium strategy and price trajectory.


"Finite-Horizon Duopolistic Competition with Sticky Prices."

Abstract: We reexamine Fershtman and Kamien's (1990) differential game model of finite-horizon duopolistic competition with sticky prices. We present a complete characterization of the feedback Nash equilibrium of the model. We also show the turnpike properties of the equilibrium strategy and price trajectory.

94-17 BARKOULAS, JOHN and C.F. Baum.

"Fragile Evidence from Cointegration-Based Tests of Exchange Market Efficiency: A Comment."

Abstract: We re-examine Sephton and Larsen's (1991) conclusion that cointegration-based tests for market efficiency suffer from temporal instability. We improve upon their research by i) including a drift term in the vector error correction model (VECM) in the Johansen procedure, and ii) correcting the likelihood ratio test statistic for finite sample bias. We show that instability of the Johansen cointegration tests disappears after accounting for these two factors.


"The Borrower's Choice of Fixed and Adjustable Rate Mortgages in the Presence of Nominal and Real Shocks."

Abstract: This paper presents an extended version of Baesel and Biger (1980) and Statman (1982). The novelty is the analysis of the borrower's demand for alternative mortgage instruments in the presence of nominal and real shocks. Another important innovation is the capability to differentiate between borrowers who are and who are not restricted by the loan-to-value constraint. Using the different exposure parameters and with the separation of borrowers according to the loan-to-value constraint the weak effect of initial income and wealth on mortgage instrument choice found in some empirical papers can be explained. other new empirically testable hypotheses are also presented.