Frictionless Equilibrium Research Articles

TECHNOLOGY, POLICY DISTORTIONS, AND THE RISE OF LARGE FARMS

AbstractBetween 1900 and 2002, mean farm size in the United States tripled; productive resources were increasingly concentrated in large farms. These observations are difficult to explain as results of profit maximization by farmers in a frictionless equilibrium model, given exogenous factor endowment and technology. I show that notable shifts in the farm size distribution coincided with important changes in farm legislation and that farm programs provided larger farms more subsidy per dollar of output produced. These farm‐level distortions are crucial for the increasing dominance of large farms but have little impact on employment and productivity in agriculture.

Stability of Radner equilibria with respect to small frictions

We study risk-sharing equilibria with trading subject to small proportional transaction costs. We show that the frictionless equilibrium prices also form an “asymptotic equilibrium” in the small-cost limit. More precisely, there exist asymptotically optimal policies for all agents and a split of the trading cost according to their risk aversions for which the frictionless equilibrium prices still clear the market. Starting from a frictionless equilibrium, this allows studying the interplay of volatility, liquidity and trading volume.

Stability of Radner Equilibria with Respect to Small Frictions

We study risk-sharing equilibria with trading subject to small proportional transaction costs. We show that the frictionless prices also form an asymptotic equilibrium in the small-cost limit. To wit, there exist asymptotically optimal policies for all agents and a split of the trading cost according to their risk aversions for which the frictionless prices still clear the market. Starting from a frictionless equilibrium, this allows to study the interplay of volatility, liquidity, and trading volume.

Asset Pricing in an International Lucas Orchard with Dynamic Learning and Catching up with the Joneses under Agents’ Heterogeneous Expectations and Preferences

This work studies asset pricing in which the model combines dynamic learning and heterogeneous habit formations with agents' heterogeneous beliefs and preferences in a continuous-time, general-equilibrium, and international endowment economy. The intertemporal and frictionless equilibrium model considers two groups of agents who have heterogeneous expectations about the future economic growth of two/N international goods and incomplete information. Additionally, the agents differ in both, with respect to the subjective rate of time preference, the levels of risk aversions and the sensitivity to habit formation. The fundamental dynamics of the economies are modeled with interaction across evolutions. The model provides closed-form solutions for all relevant equilibrium quantities. This includes also analytical solutions for asset pricing and asset allocation. With this approach we can perform a qualitative study of agents' heterogeneities and their implications on equilibrium co-movements as well as on cross-sectional asset returns within international financial markets. It is shown that the right combination of heterogeneities and learning agents matters and improves the current literature on asset pricing puzzles. The levels of the locally risk-free interest rates and the interest rates volatilities are close to the empirical findings for reasonable model parameters. The international equity premium can increase with the level of international growth interdependencies and the levels of heterogeneities. Depending on the structure of international growth interaction, the equity premia can be higher for both pessimistic and optimistic agents. International equity premia are closer to the empirical findings compared to standard models. Further, real exchange rate volatilities are much higher and more persistent compared to the literature and closer to the empirical findings. We developed an international workhorse model, which can explain simultaneously the international interest-rates puzzles, the international equity premium puzzles, the real exchange rate volatility puzzle, and the home bias puzzle, in light of a distinct structural economic analysis.

Microstructure Noise, Realized Variance, and Optimal Sampling

A recent and extensive literature has pioneered the summing of squared observed intra-daily returns, variance, to estimate the daily integrated variance of financial asset prices, a traditional object of economic interest. We show that, in the presence of market microstructure noise, realized variance does not identify the daily integrated variance of the frictionless equilibrium price. However, we demonstrate that the noise-induced bias at very high sampling frequencies can be appropriately traded off with the variance reduction obtained by high-frequency sampling and derive a mean-squared-error (MSE) optimal sampling theory for the purpose of integrated variance estimation. We show how our theory naturally leads to an identification procedure, which allows us to recover the moments of the unobserved noise; this procedure may be useful in other applications. Finally, using the profits obtained by option traders on the basis of alternative variance forecasts as our economic metric, we find that explicit optimization of realized variance's finite sample MSE properties results in accurate forecasts and considerable economic gains. Copyright 2008, Wiley-Blackwell.

The macroeconomics of the labor market: three fundamental views

We distinguish and assess three fundamental views of the labor market regarding the movements in unemployment: (i) the frictionless equilibrium view; (ii) the chain reaction theory, or prolonged adjustment view; and (iii) the hysteresis view. While the frictionless view implies a clear compartmentalization between the short- and long-run, the hysteresis view implies that all the shortrun ‡uctuations automatically turn into long-run changes in the unemployment rate. We assert the problems faced by these conceptions in explaining the diversity of labor market experiences across the OECD labor markets. We argue that the prolonged adjustment view can overcome these problems since it implies that the short, medium, and long runs are interrelated, merging with one another along an intertemporal continuum.

The Macroeconomics of the Labor Market: Three Fundamental Views

We distinguish and assess three fundamental views of the labor market regarding the movements in unempoyment: (i) the frictionless equilibrium view; (ii) the chain reaction theory, or prolonged adjustment view; and (iii) the hysteresis view. While the frictionless view implies a clear compartmentalization between the short- and long-run, the hysteresis view implies that all the short-run fluctuations automatically turn into long-run changes in the unemployment rate. We assert the problems faced by these conceptions in explaining the diversity of labor market experiences across the OECD labor markets. We argue that the prolonged adjustment view can overcome these problems since it implies that the short, medium, and long runs are interrelated, merging with one another along an intertemporal continuum.

The Macroeconomics of the Labor Market: Three Fundamental Views

We distinguish and assess three fundamental views of the labor market regarding the movements in unempoyment: (i) the frictionless equilibrium view; (ii) the chain reaction theory, or prolonged adjustment view; and (iii) the hysteresis view. While the frictionless view implies a clear compartmentalization between the short- and long-run, the hysteresis view implies that all the shortrun fluctuations automatically turn into long-run changes in the unemployment rate. We assert the problems faced by these conceptions in explaining the diversity of labor market experiences across the OECD labor markets. We argue that the prolonged adjustment view can overcome these problems since it implies that the short, medium, and long runs are interrelated, merging with one another along an intertemporal continuum.

Payout Policy Irrelevance and the Dividend Puzzle

Why do firms make large cash payouts, given the tax advantages of retention? The dividend puzzle is based on the premise that low or near-zero payouts are optimal (although not uniquely so) in frictionless markets, hence should be strictly optimal when payouts are taxed. This logic reflects misunderstandings about the nature of payout policy irrelevance in frictionless markets and the implications of adding personal taxes to the standard finance model. In frictionless markets, all optimal policies require substantial payouts. Those with low or near-zero distributions are strictly sub-optimal, and are infeasible given rational expectations. Payout policy irrelevance does not carry over to general equilibrium, so it is inappropriate to conclude that many or most firms can make low payouts for extended periods. Imposition of personal taxes perturbs the frictionless equilibrium on the margin, but does not alter the implication that all optimal policies require substantial payouts. In short, the standard finance model (with or without taxes) implies, requires, and predicts the large payouts observed in the world.