Information Friction Research Articles

Improving “national brands”: Reputation for quality and export promotion strategies

This paper studies the effect of firm and country reputation on exports when buyers cannot observe quality prior to purchase. Firm-level demand is determined by expected quality, which is driven by the dynamics of consumer learning through experience and the country of origin's reputation for quality. We show that asymmetric information can result in multiple steady-state equilibria with endogenous reputation. We identify two types of steady states: a high-quality equilibrium (HQE) and a low-quality equilibrium (LQE). In a LQE, only the lowest-quality and the highest-quality firms are active; a range of relatively high-quality firms are permanently kept out of the market by the informational friction. Countries with bad quality reputation can therefore be locked into exporting low-quality, low-cost goods. Our model delivers novel insights about the dynamic impact of trade policies. First, an export subsidy increases the steady-state average quality of exports and welfare in a LQE, but decreases both quality and welfare in a HQE. Second, there is a tax/subsidy scheme based on the duration of export experience that replicates the perfect information outcome. Third, a minimum quality standard can help an economy initially in a LQE moving to a HQE.

Inflation - Growth nexus in Ethiopia: Evidence from Threshold Auto Regressive Model

Achieving high economic growth with stable and low inflation level has long been the macroeconomic policy objective of Ethiopia. The Ethiopian economy, however, has gone through different paths of inflation and growth relationship over the last four decades. Before 2003, Ethiopia was well-known as a low inflation country with marginal economic growth. After 2004, however, the country had been in general hovering around double digit inflation. During the same period economic growth averaged 10.7%. This seems to suggest that the two variables are positively related. Quite a large number of theoretical and empirical researches, however, suggest that there is a threshold effect in the relationship between inflation and growth such that high inflation has an adverse effect on economic growth. Against this background, this paper investigates whether there is a threshold effect between the two variables in Ethiopia for the period 1971 to 2013 using annual data and Hansen’s Threshold Autoregressive (TAR) model. The empirical result does not support the existence of threshold effect between the two variables in the period. The possible reason for the non-existence of non-linearity might be related to the absence of the absence market led economic system and the low financial sector development of the study period mainly in first 25 years. As a result the informational friction that interferes with the efficiency of the financial system which finally inhibits long-run growth might be absent in the study period. Due to the small number of observations, however, this result should be interpreted with caution. Keywords: Inflation, growth and threshold autoregressive

Tradable Block Ownership, Liquidity and Threat of Exit

Large shareholders may affect managerial decisions through the threat of selling their holdings and thereby negatively influencing price. The split-share structure of Chinese corporate ownership imposes restrictions on ownership and shares trading. Using these institutional features, we test the hypothesis that the presence of a blockholder who is potentially able to trade based on private information may help discipline management and improve information disclosures, thereby improving stock liquidity. Our results show that the exit threat is closely associated with shares’ tradability and to the extent that tradable (non-tradable) blockholders can discipline management through exit threats, they exert a positive (negative) liquidity effect through both real and information friction channels. These results are robust to the possible confounding effect of liquidity-induced tradable block ownership, as shown by the difference-in-differences analysis based on the split-share structure reform, which results in an exogenous shock to the level of tradable block shares. There is evidence that the liquidity effect of tradable block ownership displays an inverted U-shape relationship, implying that exit costs rise when more tradable shares are acquired.

A Model for Information

This paper uses an approach drawn from the ideas of computer systems modelling to produce a model for information itself. The model integrates evolutionary, static and dynamic views of information and highlights the relationship between symbolic content and the physical world. The model includes what information technology practitioners call “non-functional” attributes, which, for information, include information quality and information friction. The concepts developed in the model enable a richer understanding of Floridi’s questions “what is information?” and “the informational circle: how can information be assessed?” (which he numbers P1 and P12).

SPREAD DAN STRUKTURNYA SERTA DAMPAKNYA TERHADAP STOCK RETURN DI BURSA EFEK INDONESIA

The research on the influence of bid ask spread on the stock return has been widely applied. Some of these research indicates that spread has a positive and significant effect on the stock return and the other research show that spread has a negative and significant effect on the stock return. Referring to the results of these studies, the purpose of this research is to explain why the relationship of spread and stock return is not consistent. 
 The study was conducted at the Indonesia Stock Exchange between the year 2007 and 2008 with the sample size 1.707 observations. In this study, first done decomposition of spread to information friction and real friction. Based on the decomposition of spread, further the component of information friction and real friction associated with the stock return. 
 The results of the research showed that the component of information friction has a positive and significant effect on the stock return. Furthermore, the component of real friction has a negative and significant effect on the stock return. Therefore, the inconsistency coefficient direction of the influence of spread on the stock return caused components of the spread. Furthermore, the results showed that the stock return are highly sensitive to the changes of information friction

Forecasting the Crude Oil Price with Extreme Values

AbstractExtreme values are usually given special attention. Using a decomposition-based vector autoregressive (VAR) model, this paper investigates the additional information of extreme values for forecasting the crude oil price. Empirical studies performed on the WTI spot crude oil price over year 1986-2013 are positive: decomposition-based VAR model produces significant both in-sample and out-of-sample forecast. Different evaluation tests are used and the results unanimously report the dominance of decomposition-based VAR over both efficient market model and ARIMA model. These findings are important as they hint that forecasts can be improved if high-low extreme information is properly used. An even more interesting finding is that the predictability of the crude oil price is asymmetric: crude oil price is more predictable in recession than in expansion. This finding is of great significance as it means there is information friction in the oil market especially when the oil price is in recession.

Private Information, Wage Stickiness, and Labor Market Fluctuations

This paper develops a tractable job search model with information friction to analyze the interaction between the performance-based compensation scheme and labor market fluctuations. Workers privately learn their match quality upon starting the job and keep searching for better matches. Firms post performance-based wage schedules to incentivize production. This paper demonstrates that as reflecting internal pressure (incentive provision) as well as external pressure (market fluctuation), 'across-job-wage-variations' are volatile, but 'within-job-wage-variations' moderate. In contrast to the standard search and matching model with Nash-Bargaining sharing rule, the sticky behavior of the performance-based wage scheme amplifies fluctuations in unemployment and vacancies.

Knowledge-intensive business services and economic growth with endogenous market structure

The Knowledge-Intensive Business Services (KIBS) sector has been growing in the US in the recent decades. KIBS are used to overcome the information friction between intermediate inputs and the input users that is generated by technology improvement. We use a Schumpeterian growth model with endogenous market structure to analyze the impacts of KIBS on economic growth and welfare. The model provides the full transition dynamics as well as the balanced growth path, allowing us to engage in welfare analysis. KIBS have a positive effect on the short-run growth of output and consumption, but have no impact on long-run growth because of the endogeneity of market structure. This paper shows analytically and numerically that although KIBS have only a short-run effect, a subsidy to KIBS is welfare improving.

Overcoming the Liability of Foreignness: Pre-IPO Investors from the Host Country and Foreign IPO Performance

Foreign IPO firms incur higher issuance costs than domestic firms due to greater information asymmetry and ex ante valuation uncertainty. Little is known about how to overcome such liability of foreignness. This study, based on foreign-listed Chinese firms, shows that pre-IPO financing relationship with investors from the country of listing can effectively mitigate cross-border information friction at the time of IPO, and is associated with lower underpricing, smaller underwriting spread and other offering expenses, superior post-IPO stock returns, greater analyst coverage, lower forecast error and dispersion. The benefits of pre-IPO relationship increase in firm-level information asymmetry and the strength of relationship.

Asymmetric Information, Auditing Commitment, and Economic Growth

AbstractWe analyze in this paper the growth and welfare consequences stemming from the lack of auditing commitment in a credit market with costly state verification. By studying two endogenous growth models, one of which allows lenders to commit to costly auditing strategies, whereas the other does not, we show that the inability to commit serves as a source of informational friction that results in more stringent contractual terms, which, in turn, result in lower capital accumulation, growth, and welfare. From the policy perspective, our analysis suggests a new micro‐economic channel through which institutional failings hinder economic growth and social welfare.

Improving 'National Brands': Reputation for Quality and Export Promotion Strategies

This paper studies the effect of firm and country reputation on exports when buyers cannot observe quality prior to purchase. Firm-level demand is determined by expected quality, which is driven by the dynamics of consumer learning through experience and the country of origin's reputation for quality. We show that asymmetric information can result in multiple steady-state equilibria with endogenous reputation. We identify two types of steady states: a high-quality equilibrium (HQE) and a low-quality equilibrium (LQE). In a LQE, only the lowest-quality and the highest-quality firms are active; a range of relatively high-quality firms are permanently kept out of the market by the informational friction. Countries with bad quality reputation can therefore be locked into exporting low-quality, low-cost goods. Our model delivers novel insights about the dynamic impact of trade policies. First, an export subsidy increases the steady-state average quality of exports and welfare in a LQE, but decreases both quality and welfare in a HQE. Second, there is a tax/subsidy scheme based on the duration of export experience that replicates the perfect information outcome. Third, a large reputation shock is self-fulfilling when the economy has multiple steady states. Finally, a minimum quality standard can help an economy initially in a LQE moving to a HQE, but is not necessarily welfare improving.

Security Design in Production Economy with Flexible Information Acquisition

This paper looks into security design in a production economy with a new informational friction. It highlights the investor as an expert, who may acquire costly information on the market prospect of the entrepreneur’s project and then screen it through nancing decisions. Thus, real production depends on information production, while these two are separated, which constructs a friction. Debt is optimal when the dependence of real production on information production is weak and thus the friction is not severe, and convertible preferred stock is optimal when the dependence is strong and thus the friction is severe. Such a dichotomy is unied under a new interaction between the payo structures of securities and the exible incentives to screen regarding attention allocation. Both the optimal securities and their correspondences to economic environments t in line with empirical evidence. A new approach, exible information acquisition, characterizes information sensitiveness of securities and attention allocation of investors in a state contingent way, which enables us to work with arbitrary securities on continuous states without distributional assumptions and delivers sharper predictions.

Duration of sovereign debt renegotiation

In the period since 1990, sovereign debt renegotiations take an average of five years for bank loans but only one year for bonds. We provide an explanation for this finding by highlighting one key difference between bank loans and bonds: bank loans are rarely traded, while bonds are heavily traded on the secondary market. In our theory, the secondary market plays a crucial information revelation role in shortening renegotiations. Consider a dynamic bargaining game with incomplete information between a government and creditors. The creditors' reservation value is private information, and the government knows only its distribution. Delays in reaching agreements arise in equilibrium because the government uses costly delays to screen the creditors' reservation value. When the creditors trade on the secondary market, the market price conveys information about their reservation value, which lessens the information friction and reduces the renegotiation duration. We find that the secondary market tends to increase the renegotiation payoff of the government but decrease that of the creditors while increasing the total payoff. We then embed these renegotiation outcomes in a simple sovereign debt model to analyze the ex ante welfare implications. The secondary market has the potential to increase the government ex ante welfare when the information friction is severe.

Bank Financing: A Blessing or Curse on Firm Valuation?

Bank financing reduces information friction and has several other contractual benefits for the borrowing firms. There is also cost to this relationship which is the hold-up problem. With hold-up, banks can charge non-competitive rate to relationship borrowers. Manager-shareholder conflict can also potentially distort the effect of bank financing on firm valuation. I investigate the effect of bank financing on firm valuation represented by Tobin’s Q, with these benefits and costs in mind. Previous studies either look at the announcement effect of loan on firm stock reaction or focus on the effect of relationship lending on various contractual terms, but no one has specifically looked at the impact of bank financing on firm valuation. I find that, in aggregate, bank financing has positive effect on firm valuation. Cross-sectionally, the effect of hold-up cost is more severe for small firms and firms without rating, which are subject to worse form of information asymmetry and which have less access to alternative funding sources.

TMI (Too Much Information)

Organizations have a vested interest in customers, employees, and users to disclose information within existing expectations of privacy. This empirical examination uses theoretical sampling and experimental design to identify the factors individuals consider when disclosing information within privacy expectations. The findings from a factorial vignette survey are theoretically generalizable and show that an individual’s relationship to the recipient (familiarity) and the degree to which the information is protected from being easily transferred to others (friction) positively influence the odds that disclosure is judged to be within privacy expectations. The results have implications for data gathering and management of customer, user, and employee information, and suggest a two pronged strategy for organizations targeting the disclosure of information by individuals inside and outside the organization: (1) taking into consideration the familiarity of the recipient and (2) increasing the information friction of the environment.

A Theory of Money and Banking

We construct a simple environment that combines a limited communication friction and a limited information friction in order to generate a role for money and intermediation. We ask whether there is any reason to expect the emergence of a banking sector (i.e., institutions that combine the business of money creation with the business of intermediation). In our model the unique equilibrium is characterized, in part, by the existence of an agent that: (1) creates money (a debt instrument that circulates as a means of payment); (2) lends it out (swapping it for less liquid forms of debt); (3) is responsible for monitoring those agents in control of the capital backing the illiquid debt; and (4) collects on money loans as they come due. Furthermore, the bank money in our model is a debt instrument that embeds within it important stipulations that are found in actual private money instruments. Thus, our model goes some way in addressing the questions of why private money takes the form that it does, as well as why private money is typically supplied by banks.

Pre-Trade Transparency and Informed Trading: An Experimental Approach to Hidden Liquidity

We use experimental asset markets to analyze trading under different transparency and information settings. We find that both liquidity and informed traders use undisclosed orders to compete for liquidity provision. In opaque markets, traders increase aggressiveness to improve execution probability. Without information friction, opacity enhances liquidity, especially toward the end of trading, and is beneficial for liquidity traders. Under informed trading, adverse selection drives market outcomes mainly around news announcements. Monopolistic insiders exploit opacity at the expense of large liquidity traders. Opacity does not affect informational efficiency with a monopolistic insider, but value discovery is faster with shared informational rents.

Block Ownership, Trading Activity, and Market Liquidity

AbstractWe examine the impact of block ownership on the firm’s trading activity and secondary-market liquidity. Our empirical results show that block ownership takes potential trading activity off the table relative to a diffuse ownership structure and impairs the firm’s market liquidity. These adverse liquidity effects disappear, however, once we control for trading activity. Our findings suggest that block ownership is detrimental to the firm’s market liquidity because of its adverse impact on trading activity—a real friction effect. After controlling for this real friction effect, we find little evidence that block ownership has a negative impact on informational friction. Our results suggest that the relative lack of trading, and not the threat of informed trading, explains the inverse relation between block ownership and market liquidity.

The optimal exchange rate regime for a small country

This paper examines the welfare comparisons between a freely floating, a managed floating, and a pegged exchange rate regime. We compare the expected loss under these regimes by modifying and generalizing Hamada’s (2002) model to accommodate intervention policy. We consider the de jure and de facto classifications, where the former is defined by the officially stated intentions of the monetary authorities, while the latter is based on the actually observed behavior of the nominal exchange rate. We first examine the exchange rate regimes from the central bank’s policy stance and the actual exchange rate policy. Next we assume that the regime which the private sector perceives according to an official announcement may be different from the one adopted actually by the central bank. We examine nine combinations of the de jure and de facto regimes. We interpret that, whenever they are different, there is informational friction between the central bank and the private sector. We show that the welfare level of a small country under freely floating is no less than that under other regimes, and that with some restrictive conditions, the de facto pegged or de facto managed floating is close to freely floating. This partly explains “Fear of floating” and “Fear of pegging”.

Fashion statement

We study bilateral matching under private information about agents' characteristics. Assortative matching is the only equilibrium outcome in the absence of private information. When an information friction is present, the matching process can be improved if a payoff-irrelevant variable which we term “fashion” is introduced. Informed agents choose to adopt fashion as a signaling device. If success in matching is observed, other agents can imitate the signal. Thus, for fashion to be useful, it must constantly change. If there are more than two types of agents, both “high” and “low” fashion are needed to facilitate assortative matching.