Showing papers by "National Bureau of Economic Research published in 1980"

On the Impossibility of Informationally Efficient Markets

Abstract: If competitive equilibrium is defined as a situation in which prices are such that all arbitrage profits are eliminated, is it possible that a competitive economy always be in equilibrium? Clearly not, for then those who arbitrage make no (private) return from their (privately) costly activity. Hence the assumptions that all markets, including that for information, are always in equilibrium and always perfectly arbitraged are inconsistent when arbitrage is costly. We propose here a model in which there is an equilibrium degree of disequilibrium: prices reflect the information of informed individuals (arbitrageurs) but only partially, so that those who expend resources to obtain information do receive compensation. How informative the price system is depends on the number of individuals who are informed; but the number of individuals who are informed is itself an endogenous variable in the model. The model is the simplest one in which prices perform a well-articulated role in conveying information from the informed to the uninformed. When informed individuals observe information that the return to a security is going to be high, they bid its price up, and conversely when they observe information that the return is going to be low. Thus the price system makes publicly available the information obtained by informed individuals to the uninformed. In general, however, it does this imperfectly; this is perhaps lucky, for were it to do it perfectly , an equilibrium would not exist. In the introduction, we shall discuss the general methodology and present some conjectures concerning certain properties of the equilibrium. The remaining analytic sections of the paper are devoted to analyzing in detail an important example of our general model, in which our conjectures concerning the nature of the equilibrium can be shown to be correct. We conclude with a discussion of the implications of our approach and results, with particular emphasis on the relationship of our results to the literature on "efficient capital markets."

Domestic Saving and International Capital Flows

Abstract: How internationally mobile is the world's supply of capital? Does capital flow among industrial countries to equalize the yield to investors? Alternatively, does the saving that originates in a country remain 'to be invested there? Or does the truth lie somewhere between these two extremes? The answers to these questions are not only important for understanding the international capital market but are also critical for analyzing a wide range of issues including the nation's optimal rate of saving and the incidence of tax changes. (This abstract was borrowed from another version of this item.)

The Determinants of the Variability of Stock Market Prices

Abstract: The most familiar interpretation for the large and unpredictable swings that characterize common stock price indices is that price changes represent the efficient discounting of "new information." It is remarkable given the popularity of this interpretation that it has never been established what this information is about. Recent work by Shiller, and Stephen LeRoy and Richard Porter, has shown evidence that the variability of stock price indices cannot be accounted for by information regarding future dividends since dividends just do not seem to vary enough to justify the price

Output Effects of Government Purchases

Abstract: Because of a small direct negative effect on private spending, temporary variations in government purchases as in wartime, would have a strong positive effect on aggregate demand. Intertemporal substitution effects would direct work and production toward these periods where output was valued unusually highly. Defense purchases are divided empirically into "permanent" and "temporary" components by considering the role of (temporary) wars. Shifts in non-defense purchases are mostly permanent. Empirical results verify a strong expansionary effect on output of temporary purchases, but contradict some more specific expectational propositions.

An Empirical Model of Labor Supply in a Life Cycle Setting

Abstract: This paper formulates and estimates a structural life cycle model of labor supply. Using theoretical characterizations derived from an economic model of life cycle behavior, a two-stage empirical analysis yields estimates of intertemporal and uncompensated substitution effects which provides the information needed to predict the response of hours of work to life cycle wage growth and shifts in the lifetime wage path. The empirical model developed here provides a natural framework for interpreting estimates found in other work on this topic. It also indicates how cross section specifications of hours of work can be modified to estimate parameters relevant for describing labor supply behavior in a lifetime setting.

Solution and Maximum Likelihood Estimation of Dynamic Nonlinear Rationalexpectations Models

Abstract: A solution method and an estimation method for nonlinear rational expectations models are presented in this paper. The solution method can be used in forecasting and policy applications and can handle models with serial correlation and multiple viewpoint dates. When applied to linear models, the solution method yields the same results as those obtained from currently available methods that are designed specifically for linear models. It is, however, more flexible and general than these methods. For large nonlinear models the results in this paper indicate that the method works quite well. The estimation method is based on the maximum likelihood principal. It is, as far as we know, the only method available for obtaining maximum likelihood estimates for nonlinear rational expectations models. The method has the advantage of being applicable to a wide range of models, including, as a special case, linear ,models. The method can also handle different assumptions about the expectations of the exogenous variables, something which is not true of currently available approaches to linear models.

On Estimating the Expected Return on the Market: An Exploratory Investigation

Abstract: The expected market return is a number frequently required for the solution of many investment and corporate finance problems, but by comparison with other financial variables, there has been little research on estimating this expected return Current practice for estimating the expected market return adds the historical average realized excess market returns to the Current observed interest rate While this model explicitly reflects the dependence of the market return on the interest rate, it fails to account for the effect of changes in the level of market risk Three models of equilibrium expected market returns which reflect this dependence are analyzed in this paper Estimation procedures which incorporate the prior restriction that equilibrium expected excess returns on the market must be positive arc derived and applied to return data for the period 1926- 1978 The principal conclusions from this exploratory investigation are: (1) in estimating models of the expected market return the non-negativity restriction of the expected excess return should be explicitly included as part of the specification; (2) estimators which use realized returns should be adjusted for heteroscedasticity

Strict Liability Versus Negligence

Abstract: The aim of this article is to compare strict liability and negligence rules on the basis of the incentives the provide to "appropriately" reduce accident losses. It will therefore be both convenient and clarifying to abstract from other issues in respect to which the rules could be evaluated. In particular, there will be no concern with the bearing of risk - for parties will be presumed risk neutral - nor with the size of "administrative costs" - for the legal system will be assumed to operate free of such costs - nor with distributional equity - for the welfare criterion will be taken to be the following aggregate: the benefits derived by parties from engaging activities less total accident losses less total accident prevention costs.

Trade Policy as an Input to Development

Abstract: My topic is the question: what difference does the set of commercial policies chosen by a developing country make to its rate of economic growth? Three points are salient. First, in its present state, trade theory provides little guidance as to the role of trade policy and trade strategy in promoting growth. Second, the empirical evidence overwhelmingly indicates that there are important links between them. Third, a number of hypotheses as to the reasons for these links have been put forward, but there is not as yet sufficient evidence to enable us to estimate their relative importance.

Government Deficits and Aggregate Demand

Abstract: The evidence presented in this paper indicates that changes in government spending, transfers and taxes can have substantial effects on aggregate demand The estimates also indicate that the promise of future social security benefits significantly reduces private saving Each of the basic implications of the so-called "Ricardian equivalence theorem" is contradicted by the data The results are consistent with the more general view of the effects of fiscal actions and fiscal expectations that is described in the paper

The Use of Volatility Measures in Assessing Market Efficiency

Abstract: My initial motivation for considering volatility measures in the efficient markets models was to clarify the basic smoothing properties of the models to allow an understanding of the assumptions which are implicit in the notion of market efficiency. The efficient markets models, which are described in section II below ,relate a price today to the expected present value of a path of future variables. Since present values are long weighted moving averages, it would seem that price data should be very stable and smooth. These impressions can be formalized in terms of inequalities describing certain variances (section III). The results ought to be of interest whether or not the data satisfy these inequalities, and the procedures ought not to be regarded as just "another test" of market efficiency. Our confidence of our understanding of empirical phenomena is enhanced when we learn how such an obvious property of data as its "smoothness" relates to the model, and to alternative models (section IV below).On further examination of the volatility inequalities, it became clear that the inequalities may also suggest formal tests of market efficiency that have distinct advantages over conventional tests. These advantages take the form of greater power in certain circumstances of robustness to data errors such as misalignment and of simplicity and understandability. An interpretation of volatility tests versus regression tests in terms of the likelihood principle is offered in section V.

The Location of Overseas Production and Production for Export by U.S. Multinational Firms

Abstract: The location of overseas manufacturing production by U.S. firms seems to have been strongly influenced by common factors that operate in all industries: notably proximity to the United States and to other markets. Within industries, the choices made by parent firms among locations appear to show a tendency of "opposites attract," with low-wage and low-capital-intensity parents choosing high-wage, high-capital intensity countries and high-wage, high-capital-intensity parents making the opposite choice. Production for export seems to have been most strongly attracted by large internal markets in host countries. Economies of scale in production presumably made large markets also economical as export bases. Another factor was high trade propensities of host countries, which we interpret as representing access to imported materials at low world prices or better transport, finance, and other trade facilities. Labor cost seems to have been a weak influence on location choices. U.S. firms tended to export from high-wage countries but the high productivity in such countries more than offset the high wages. However, labor cost, to the extent we could measure it, was not in general a major influence on the location of export production.

Changes in the Propensity to Live Alone: 1950–1976

Abstract: The growth in single-person households is a pervasive behavioral phenomenon in the United States in the post-war period. In this paper we investigate determinants of the propensity to live alone, using 1970 data across states for single men and women ages 25 to 34 and for elderly widows. Income level appears to be a major determinant of the propensity to live alone. The estimated cross-state equations track about three-quarters of the increase in the propensity to live alone between 1950-1976and suggest that income growth has been the principal identified influence. Other variables found to affect (positively) the propensity to live alone include mobility, schooling level, and for young people a measure of social climate; non-whites appear to have a somewhat lower propensity to live alone.

Efficiency of Foreign Exchange Markets and Measures of Turbulence

Abstract: Since the move to generalized floating in1973, exchange rates between major currencies have displayed large fluctuations. This turbulence of foreign exchange rates is an important concern of government policy and its explanation is a challenge for theories of foreign exchange market behavior. In Section I of this paper, we document the extent of turbulence in foreign exchange markets by examining (i) the magnitude of short-run variations in exchange rates relative to other measures of economic variability; (ii) the degree of divergence between actual and expected changes in exchange rates; and (iii) the extent to which exchange-rate movements have diverged from movements of relative national price levels. In Section II, we provide a general explanation of this turbulence in terms of the modern "asset market theory" to exchange-rate determination. This theory emphasizes that exchange rates, like the prices of other assets determined in organized markets, are strongly influenced by the market's expectation of future events. In this context, we also discuss the narrower technical question of "foreign exchange market efficiency." Finally, in Section III, we address the question of whether turbulence in the foreign exchange markets has been "excessive" and what policy measures can (or should) be taken to reduce it.

Time Preference and Health: An Exploratory Study

Abstract: This paper reports the results of an exploratory survey designed to measure differences in time preference across individuals and to test for relationships between time preference and schooling, health behaviors, and health status. Approximately 500 adults age 25-64 were surveyed by telephone. Time preference was measured by a series of six questions asking the respondent to choose between a sum of money now and a larger sum at a specific point in the future. Approximately two-thirds gave consistent replies to the six questions. The implicit interest rate revealed in their replies is weakly correlated with years of schooling (negative), cigarette smoking (positive), and health status(negative). Family background, especially religion, appears to be an important determinant of time preference.

Wages, Profits, and Macroeconomic Adjustment: A Comparative Study

Abstract: The behavior of real wages has complicated macroeconomic policy in the industrialized world during the 1970s. Many commentators have discussed the extraordinary increase in wage inflation in Europe and Japan at the end of the last decade. Few have noted that the nominal wage gains resulted in remarkable increased in real wages. The five large economies outside North America in the Organization for Economic Cooperation and Development (OECD) had rapid growth of real hourly compensation in 1969-73, along with high rates of increase of nominal compensation. In most large OECD economies, real wages in the late 1960s grew faster than productivity, so that the distribution of income shifted toward labor, while the rate of return on capital was substantially reduced.

On the Possibility of an Inverse Relationship between Tax Rates and Government Revenues

Abstract: When Arthur Laffer or other "supply side advocates" plot total tax revenue as a function of a particular tax rate, he draws an upward sloping segment called the normal range, followed by a downward sloping segment called the prohibitive range. Since a given revenue can be obtained with either of two tax rates, government would minimize total burden by choosing the lower rate of the normal range. A brief literature review indicates that tax rates on the prohibitive range in theoretical and empirical models have been the result of particularly high tax rates, high elasticity parameters, or both. Looking at labor tax rates and total revenue, for example, the tax rate which maximizes revenue will depend on the assumed labor supply elasticity. This paper introduces a new curve which summarizes the tax rate and elasticity combinations that result in maximum revenues, separating the "normal area" from the "prohibitive area." A general-purpose empirical U.S. general equilibrium model is used to plot the Laffer curve for several elasticities, and to plot the newly introduced curve using the labor tax example. Results indicate that the U.S. could conceivably be operating in the prohibitive area, but that the tax wedge and/or labor supply elasticity would have to be much higher than most estimates would suggest.

The Role of Intergenerational Transfers in Aggregate Capital Accumulation

Abstract: This paper uses historicaI U.S. data to directly estimate the contribution of intergenerational transfers to aggregate capital accumulation. The evidence presented indicates that intergenerational transfers account for the vast majority of aggregate U .S. capital formation; only a negligible fraction of actual capital accumulation can be traced u, life-cycle or "hump" savings. A major difference between this study and previous investigations of this issue is the use of more accurate longitudinal age-earnings and age-consumption profiles. These profiles are simply too flat to generate substantial lifecycle savings. This paper suggests the importance of and need for substantially greater research and data collection on intergenerational transfers. fife-cycle models of savings that emphasize savings for retirement as the dominant form of apical accumulation should give way to models that illuminate the determinants of intergenerational transfers.

The Role of Money Supply Shocks in the Short-Run Demand for Money

Abstract: Previous models of the demand for money are either inconsistent with contemporaneous adjustment of the price level to expected changes in the nominal money supply or imply implausible fluctuations in interest rates in response to unexpected changes in the nominal money supply. This paper proposes a shock-absorber model of money demand in which money supply shocks affect the synchronization of purchases and sales of assets and so engender a temporary desire to hold more or less money than would otherwise be the case. Expected changes in nominal money do not cause fluctuations in real money inventories. The model is simultaneously estimated for the United States, United Kingdom, Canada, France, Germany, Italy, Japan, and the Netherlands using the postwar quarterly data set and instruments used in the Mark III International Transmission Model. The shock-absorber variables significantly improve the estimated short-run money demand functions in every case.

Do Stock Prices Move Too Much to Be Justified by Subsequent Changes in Dividends

Abstract: This paper will develop the efficient markets model in Section I to clarify some theoretical questions that may arise in connection with the inequality (1) and some similar inequalities will be derived that put limits on the standard deviation of the innovation in price and the standard deviation of the change in price. The model is restated in innovation form which allows better understanding of the limits on stock price volatility imposed by the model. In particular, this will enable us to see (Section II) that the standard deviation of p is highest when information about dividends is revealed smoothly and that if information is revealed in big lumps occasionally the price series may have higher kurtosis (fatter tails) but will have lower variance. The notion expressed by some that earnings rather than dividend data should be used is discussed in Section III, and a way of assessing the importance of time variation in real discount rates is shown in Section IV. The inequalities are compared with the data in Section V.

Employment Fluctuations and Wage Rigidity

Abstract: No abstract is available for this paper.

Wages, Flexible Exchange Rates, and Macroeconomic Policy

Abstract: In an open economy with a floaLing exchange rate, the efficacy of fiscal and monetary policy depends fundamentally on the wage-setting pnxiess. In the canonical models of Mundell and Fleming, monetary expansion raises output via an exchange rate depreciation, while fiscal expansion has no output effect. These results hold only when real wages can be altered by exchange rate movements; if the real wage is fixed, the Mundell-Fleming ranking of policy is reversed. This paper explores the interaction of wages and policy in short- and long-run models, under the assumptions of perfect foresight and world capital mobility. After seven years of floating exchange rates, the implications of Hexible rates for countercyclical macroeconomic policy remain in douht. The traditional view, following the pioneering work of Mundell 1196;?) and Fleming [1962] (henceforth M-F), is that expansionary monetary policy, hy inducing depreciation ofthe real exchange rate, is effective in raising output in a small, underemployed economy. Fiscal policy, on the other hand, is seen as less effective. In the standard analysis, a rise in government spending leads to appreciation and crowding-out of net exports. An alternative view of flexihle rates, set forth in the full-employment models of glohal monetarism, maintains that a money supply expansion can change only the exchange rate and price level, but not output and employment. While an increase in money causes depreciation ofthe nominal exchange rate, the domestic price level rises to offset the competitive gain envisaged in the M-F model. The alternative view has had less to say on the effects of fiscal policy and on the general question of prolonged unemployment. Both views of monetary policy have adherents, and there is evidence, in different countries and at different times, to support each. Their appropriateness, I shall argue here, depends crucially on the nature of the wage-determination process. The M-F model (in an extended form) requires that nominal exchange-rate changes alter the real wage.^ Implicit is an underlying view, going hack to Keynes,

Realized Returns on Common Stock Investments: The Experience of Individual Investors

Abstract: Over the last decade and a half, individual investors in the aggregate have consistently been net sellers of corporate common stocks; simultaneously, the holdings of equities by mutual funds, pension funds, insurance companies, and bank trust funds on behalf of individuals have increased dramatically (Soldofsky 1971; U.S. Securities and Exchange Commission 1971; Board Virtually all existing empirical studies of the American capital market deal with the investment performance record of institutions. The present paper offers data on the investment experiences of a large and representative sample of individual investors, based on a 7-year history of actual trading behavior. Those experiences suggest some reasonable skill in security selection, particularly in connection with shortterm trading cycles. Transactions costs, however, have a substantial impact on realized net returns, rendering the overall performance results observed similar to those available from passive investment strategies over corresponding calendar periods. Financial support for the investigation was provided by the National Bureau of Economic Research, the Investment Company Institute (ICI), the Purdue Research Foundation, the College of Business at the University of Utah, and the brokerage house from whose customer group the investor sample was drawn. The computations were performed at the computer centers of Purdue University and the University of Utah. A substantial portion of the requisite securities price data were obtained from the Wells Fargo Bank of San Francisco, which made available its stock data file to Purdue for the research. Particular thanks are also due: William Elbring of Purdue for his contributions to the computer programming effort; Robert Lipsey and Christine Mortensen of the NBER for their counsel and administrative support; Alfred Johnson of the ICI; James Lorie, Myron Scholes, and Lawrence Fisher of the University of Chicago, for the opportunity to review the findings at seminars sponsored by the Center for Research in Security Prices; James Jenkins, Donald Farrar, and Ramon Johnson of the University of Utah; Edgar Pessemier, Frank Bass, and Donald King of Purdue University; John Lintner of Harvard University; and Marshall Blume of the University of Pennsylvania. The responsibility for the findings is, of course, the authors' alone. While the paper represents a segment of an NBER project, it has not undergone a full critical review by the NBER and should not be considered an official NBER publication.

Reconsidering the Work Disincentive Effects of Social Security

Abstract: This paper shows that, contrary to commonly held views, the provisions of the social security law actually provide strong work incentives for older men. The reason is that, for most workers, higher current earnings lead to higher future social security benefits. These incentives have been particularly strong for workers under 65 years of age and, although they will be reduced somewhat when the 1977 amendments to the social security law become fully effective, they will remain substantial. The findings raise serious questions about recent econometric work attributing the decline in labor force participation rates of older men to the social security system.

Exchange Rates, Prices and Money: Lessons from the 1920s

Abstract: This paper summarizes the results of an empirical study of the operation of flexible exchange rates during the 1920's under both the hyperinflationary conditions (based on the experience of Germany) and under the normal conditions (based on the experience of Britain, the United States and France).Section I deals with some general characteristics of the market for foreign exchange by examining the relationship between spot and forward exchange rates. Section II deals with the relationship between exchange rates and prices by examining aspects of the purchasing power parity doctrine. Section III deals with the determinants of exchange rates within the context of a simple monetary model.

Oil and the Dollar

Abstract: This paper develops a simple theoretical model of the effect of an oil price increase on exchange rates. The model shows that the direction of this effect depends on a comparison of the direct balance of payments burden of the higher oil price with the indirect balance of payments benefits of OPEC spending and investment. In the short run, what matters is whether the U.S. share of world oil imports is more or less than its share of OPEC asset holdings; in the long run, whether its share of oil imports is more or less than its share of OPEC imports. Casual empiricism suggests that the initial effect and the long run effect will run in opposite directions: an oil price increase will initially lead to dollar appreciation, but eventually leads to dollar depreciation.

Strict Liability Versus Negligence in a Market Setting

Abstract: This paper formally analyzes strict liability and negligence in a market setting. The discussion emphasizes the impact of the rules on the market price and on the number of firms in the industry. For simplicity, the damage caused by each firm is assumed to be determined only by that firm's "care" (and not also by the firm's output or the victim's behavior).

An Exploration into the Determinants of Research Intensity

Abstract: This paper explores the economic factors which determine the variation of research effort across firms. The intra-industry coefficient of variation of research intensity is much larger than those of traditional factors. We show that this important fact is consistent with the theoretical argument that knowledge possesses unique economic characteristics, and that the demand for research depends both on the parameters of the production function for knowledge and on the ability of the firm to appropriate the benefits from the knowledge it produces. We propose and implement a framework for decomposing the observed intra-industry variance In research intensity into three components: demand inducement, a firm-specific structural parameter, and errors in the observed variables. The main empirical findings are that errors in the variables (especially research) are important, that very little of the structural variance in research intensity is accounted for by demand inducement, and that the bulk of the variance is related to differences in the firm-specific parameter. Both the theoretical and empirical analysis indicate that it is not reasonable to treat the demand for research in a manner analogous to the demand for traditional inputs, including capital. Substantially richer models are required to provide insight into the structure of incentives driving the demand for research.