Information Processing and Limited Liability

By Bartosz Mackowiak and Mirko Wiederholt

American Economic Review, May 2012

Decision-makers often face limited liability and thus know that their loss will be bounded. We study how limited liability affects the behavior of an agent who chooses how much information to acquire and process in order to take a good decision. We find t...

Information Choice Technologies

By Christian Hellwig, Sebastian Kohls, and Laura Veldkamp

American Economic Review, May 2012

Theories based on information costs or frictions have become increasing popular in macroeconomics and macro-finance. The literature has used various types of information choices, such as rational inattention, inattentiveness, information markets and costl...

Prospect Theory as Efficient Perceptual Distortion

By Michael Woodford

American Economic Review, May 2012

The paper proposes a theory of efficient perceptual distortions, in which the statistical relation between subjective perceptions and the objective state minimizes the error of the state estimate, subject to a constraint on information processing capacity...

Salience in Experimental Tests of the Endowment Effect

By Pedro Bordalo, Nicola Gennaioli, and Andrei Shleifer

American Economic Review, May 2012

We provide a novel account of experimental evidence for the endowment effect using the salience mechanism (Bordalo, Gennaioli, and Shleifer, 2011). The two-stage procedure implemented in experiments implies that the endowed good and other goods are evalua...

Getting at Systemic Risk via an Agent-Based Model of the Housing Market

By John Geanakoplos, Robert Axtell, J. Doyne Farmer, Peter Howitt, Benjamin Conlee, Jonathan Goldstein, Matthew Hendrey, Nathan M. Palmer, and Chun-Yi Yang

American Economic Review, May 2012

Systemic risk must include the housing market, though economists have not generally focused on it. We begin construction of an agent-based model of the housing market with individual data from Washington, DC. Twenty years of success with agent-based mod...

Capital Shortfall: A New Approach to Ranking and Regulating Systemic Risks

By Viral Acharya, Robert Engle, and Matthew Richardson

American Economic Review, May 2012

The financial crisis of 2007-2009 has given way to the sovereign debt crisis of 2010-2012, yet many of the banking issues remain the same. We discuss a method to estimate the capital that a financial firm would need to raise if we have another financial ...

Privacy-Preserving Methods for Sharing Financial Risk Exposures

By Emmanuel A. Abbe, Amir E. Khandani, and Andrew W. Lo

American Economic Review, May 2012

The financial industry relies on trade secrecy to protect its business processes and methods, which can obscure critical financial risk exposures from regulators and the public. Using results from cryptography, we develop computationally tractable protoc...

Fiscal Policy and the Great Recession in the Euro Area

By Günter Coenen, Roland Straub, and Mathias Trabandt

American Economic Review, May 2012

How much did fiscal policy contribute to euro area real GDP growth during the Great Recession? We estimate that discretionary fiscal measures have increased annualized quarterly real GDP growth during the crisis by up to 1.6 percentage points. We obtain o...

Fiscal Policy in a Financial Crisis: Standard Policy versus Bank Rescue Measures

By Robert Kollmann, Werner Roeger, and Jan in't Veld

American Economic Review, May 2012

A key dimension of fiscal policy during the financial crisis was massive government support for the banking system. The macroeconomic effects of that support have, so far, received little attention in the literature. This paper fills this gap, using a qua...

Bubbles and Total Factor Productivity

By Jianjun Miao and Pengfei Wang

American Economic Review, May 2012

This paper presents an infinite-horizon model of production economies in which firms face idiosyncratic productivity shocks and are subject to endogenous credit constraints. Credit-driven stock price bubbles can arise which can relax credit constraints an...

Debt Financing in Asset Markets

By Zhiguo He and Wei Xiong

American Economic Review, May 2012

We study rollover risk and collateral value in a dynamic asset pricing model with endogenous debt financing by extending the framework of Geanakoplos (2009) with a generic binomial tree and time-varying heterogeneous beliefs. Optimistic borrowers face rol...

Understanding Bubbly Episodes

By Vasco M. Carvalho, Alberto Martin, and Jaume Ventura

American Economic Review, May 2012

Over the last two decades US aggregate wealth has fluctuated substantially. Against the backdrop of the Great Recession, the effects of these boom-and-bust cycles have come to dominate academic and policy discussions. How can we explain these fluctuations...

The Safe-Asset Share

By Gary Gorton, Stefan Lewellen, and Andrew Metrick

American Economic Review, May 2012

We document that the percentage of all U.S. assets that are "safe" has remained stable at about 33 percent since 1952. This stable ratio is a rare example of calm in a rapidly changing financial world. Over the same time period, the ratio of U.S. assets...

Three Principles for Market-Based Credit Regulation

By Perry Mehrling

American Economic Review, May 2012

A key lesson of the financial crisis 2007-09 is that the Bagehot Rule, "lend freely but at a high rate," needs to be updated for the emerging market-based credit system. A modern rule is suggested: Markets, not Banks; Outside spread, not Inside spread;...

Limited-Purpose Banking--Moving from "Trust Me" to "Show Me" Banking

By Christophe Chamley, Laurence J. Kotlikoff, and Herakles Polemarchakis

American Economic Review, May 2012

There are many alleged culprits for the bank runs of 2008 and their devastating economic fallout. But proprietary information and leverage top our list. Claims of proprietary information forced financial markets to operate on trust, while providing the p...

Within-City Variation in Urban Decline: The Case of Detroit

By Veronica Guerrieri, Daniel Hartley, and Erik Hurst

American Economic Review, May 2012

When a city experiences a decline in income or population, do all neighborhoods within the city decline equally? Or, do some neighborhoods decline more than others? What are the characteristics of the neighborhoods that decline the most? We answer thes...

Housing Booms and City Centers

By Edward L. Glaeser, Joshua D. Gottlieb, and Kristina Tobio

American Economic Review, May 2012

Popular discussions often treat the great housing boom of the 1996-2006 period as if it were a national phenomenon with similar impacts across locales, but across metropolitan areas, price growth was dramatically higher in warmer, less educated cities wit...

Heterogeneity in Neighborhood-Level Price Growth in the United States, 1993-2009

By Fernando Ferreira and Joseph Gyourko

American Economic Review, May 2012

Examination of detailed geographical information on U.S. housing transactions from 1993 to 2009 find much heterogeneity at the neighborhood level in when the recent boom began, how big the initial jumps in price growth were, how long the booms lasted, and...

Market Prices of Risk with Diverse Beliefs, Learning, and Catastrophes

By Timothy Cogley, Thomas J. Sargent, and Viktor Tsyrennikov

American Economic Review, May 2012

We compare market prices of risk in economies with identical patterns of endowments, priors, and information flows, but two different market structures, one with complete markets, another in which consumers can trade only a single risk-free bond. We study...

Financial Innovation and Asset Price Volatility

By Felix Kubler and Karl Schmedders

American Economic Review, May 2012

We compare asset prices in an overlapping generations model for incomplete and complete markets. Individuals within a generational cohort have heterogeneous beliefs about future states of the economy and thus would like to make bets against each other. In...