The dynamics of public investment under persistent electoral advantage

This paper studies the effects of asymmetries in re-election probabilities across parties on public policy and its subsequent propagation to the economy. The struggle between opposing groups — that disagree on the composition of public consumption — results in governments being endogenously short-sighted: Systematic under investment in infrastructure and overspending on public goods arise, as resources are more valuable when in power. Because the party enjoying an electoral advantage is relatively less short-sighted, it devotes a larger proportion of government revenues to productive public investment. Political turnover, together with asymmetric policy choices, induces economic fluctuations in an otherwise deterministic environment. The author characterizes the long-run distribution of capital and shows that output increases on average with political advantage, despite the fact that the size of the government expands as a percentage of GDP. Volatility, on the other hand, is non-monotonic in political power and is an additional source of inefficiency.Political science ; Expenditures, Public

A Behavioural Approach To Financial Puzzles

Many financial puzzles have been solved, at least partially, by the introduction of alternative assumptions on the behaviour of investors. Cumulative prospect theory and mental accounting are two such approaches which are used in this paper to analyze some of the most important financial puzzles. We first focus our attention on anomalies (or considered as such in the standard expected utility model) at the individual level, for example the disposition effect or the low diversification puzzle. We then address two aggregate puzzles, namely the equity premium puzzle and the return predictability puzzle. We show how recent behavioral models allow to explain these anomalies in a very natural way.

Mesoscopic modelling of financial markets

We derive a mesoscopic description of the behavior of a simple financial market where the agents can create their own portfolio between two investment alternatives: a stock and a bond. The model is derived starting from the Levy-Levy-Solomon microscopic model (Econ. Lett., 45, (1994), 103--111) using the methods of kinetic theory and consists of a linear Boltzmann equation for the wealth distribution of the agents coupled with an equation for the price of the stock. From this model, under a suitable scaling, we derive a Fokker-Planck equation and show that the equation admits a self-similar lognormal behavior. Several numerical examples are also reported to validate our analysis

Precautionary saving and portfolio allocation: DP by GMM

There is much research on consumption-savings problems with risky labor income and a constant interest rate and also on portfolio allocation with risky returns but nonstochastic labor income. Less is known quantitatively about the interaction between the two forms of risk. Under CRRA utility, undiversifiable income risk should be reflected in both savings rates and portfolio allocations. To quantify these effects in a model of consumption and portfolio choice, we adopt a semi-parametric projection method for solving dynamic programmes, based on generalized method of moments estimation of the parameters of approximate decision rules. We find that background income risk does affect optimal portfolios but that this effect may be difficult to detect empirically.portfolio theory, precautionary saving

Why Money Trickles Up - Wealth & Income Distributions

This paper combines ideas from classical economics and modern finance with the general Lotka-Volterra models of Levy & Solomon to provide straightforward explanations of wealth and income distributions. Using a simple and realistic economic formulation, the distributions of both wealth and income are fully explained. Both the power tail and the log-normal like body are fully captured. It is of note that the full distribution, including the power law tail, is created via the use of absolutely identical agents. It is further demonstrated that a simple scheme of compulsory saving could eliminate poverty at little cost to the taxpayer.Comment: 45 pages of text, 36 figure

Agent-Based Computational Economics: A Constructive Approach to Economic Theory

This chapter explores the potential advantages and disadvantages of Agent-based Computational Economics (ACE) for the study of economic systems. General points are concretely illustrated using an ACE model of a two-sector decentralized market economy. Six issues are highlighted: Constructive understanding of production, pricing, and trade processes; the essential primacy of survival; strategic rivalry and market power; behavioral uncertainty and learning; the role of conventions and organizations; and the complex interactions among structural attributes, behaviors, and institutional arrangements. Extensive annotated pointers to ACE surveys, research, course materials, and software can be accessed here: http://www.econ.iastate.edu/tesfatsi/ace.htmagent-based computational economics; Learning; network formation; decentralized market economy

Agent-based modeling to investigate the disposition effect in financial markets

One of the behavioral patterns that deviate from what is predicted by traditional financial theories is the disposition effect. Although most empirical studies have reported a significant disposition effect, researchers have yet to conduct a conclusive test of thiseffect because a competing hypothesis or confounding effects might explain the documented significance. Thus, we use the tools of computational intelligence, instead of empirical approaches, to explore market behavior. In particular, we allow agents with different investment strategies to interact and to compete with each other in an artificial futures market. We found that the S-shaped value curve proposed by prospect theory may be one of the causes of the observed behavior of the disposition effect. However, rational expectation such as short-term mean reversion can even be more decisive

Self-fulfilling liquidity dry-ups

Secondary markets for long-term assets might be illiquid due to adverse selection. In a model in which moral hazard is confined to project initiation, I find that: (1) when agents expect a liquidity dry-up on such markets, they optimally choose to self-insure through the hoarding of non-productive but liquid assets; (2) such a response has negative externalities as it reduces ex-post market participation, which worsens adverse selection and dries up market liquidity; (3) liquidity dry-ups are Pareto inefficient equilibria; (4) the Government can rule them out. Additionally, when agents face idiosyncratic, privately known, illiquidity shocks, I show that: (5) it increases market liquidity; (6) illiquid agents are better-off when they can credibly disclose their liquidity position, but transparency has an ambiguous effect on risk-sharing possibilities.Liquidity, Liquidity Dry-ups, Financial Crises, Hoarding, Adverse Selection, Self-insurance

Liquidity demand and welfare in a heterogeneous-agent economy

This paper provides an analytically tractable general-equilibrium model of money demand with micro-foundations. The model is based on the incomplete-market model of Bewley (1980) where money serves as a store of value and provides liquidity to smooth consumption. The model is applied to study the effects of monetary policies. It is shown that heterogeneous liquidity demand can lead to sluggish movements in aggregate prices and positive responses from aggregate output to transitory money injections. However, permanent money growth can be extremely costly: With log utility function and an endogenously determined distribution of money balances that matches the household data, agents are willing to reduce consumption by 8% (or more) to avoid 10% annual inflation. The large welfare cost of inflation arises because inflation destroys the liquidity value and the buffer-stock function of money, thus raising the volatility of consumption for low-income households. The astonishingly large welfare cost of moderate inflation provides a justification for adopting a low inflation target by central banks and offers an explanation for the empirical relationship between inflation and social unrest in developing countries.Liquidity (Economics)

Do tropical typhoons smash community ties? Theory and evidence from Vietnam

Natural disasters trigger large inequalities between affected households and the rest of the community. The extent to which villages compensate for these shocks allegedly depends on the pressure imposed by the group of needy families. I model two major threats to redistribution - (i) the emergence of acoalition of winners willing to shy away from redistributing to their peers and (ii) the initial fractionalization of the community. Matching data on a wave of tropical typhoons with a panel household survey in Vietnam, I find less redistribution in villages where needy families are in the minority. Whereas 17 cents on average are covered through informal transfers for a relative income loss of $1, access to liquidity falls below 10 cents when heavily affected households are isolated in the commune. In line with the existing literature, minorities participate less in the resources reallocation. Despite these barriers to full insurance, risk-sharing through informal transfers is still economically significant. This result is related with the findings that communities having suffered important trauma show greater signs of resilience and cohesiveness.natural disasters ; informal risk-sharing ; social insurance ; altruism