Gabaix, XavierOverview
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Most widely held works by
Xavier Gabaix
Shrouded attributes, consumer myopia, and information suppression in competitive markets
by Xavier Gabaix
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10 editions published between 2004 and 2005 in English and held by 63 WorldCat member libraries worldwide "Bayesian consumers infer that hidden addon prices (e.g. the cost of ink for a printer) are likely to be high prices. If consumers are Bayesian, firms will not shroud information in equilibrium. However, shrouding may occur in an economy with some myopic (or unaware) consumers. Such shrouding creates an inefficiency, which firms may have an incentive to eliminate by educating their competitors' customers. However, if addons have close substitutes, a "curse of debiasing" arises, and firms will not be able to profitably debias consumers by unshrouding addons. In equilibrium, two kinds of exploitation coexist. Optimizing firms exploit myopic consumers through marketing schemes that shroud highpriced addons. In turn, sophisticated consumers exploit these marketing schemes. It is not possible to profitably drive away the business of sophisticates. It is also not possible to profitably lure either myopes or sophisticates to nonexploitative firms. We show that informational shrouding flourishes even in highly competitive markets, even in markets with costless advertising, and even when the shrouding generates allocational inefficiencies"National Bureau of Economic Research web site
Institutional investors and stock market volatility
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7 editions published between 2005 and 2010 in English and held by 54 WorldCat member libraries worldwide "We present a theory of excess stock market volatility, in which market movements are due to trades by very large institutional investors in relatively illiquid markets. Such trades generate significant spikes in returns and volume, even in the absence of important news about fundamentals. We derive the optimal trading behavior of these investors, which allows us to provide a unified explanation for apparently disconnected empirical regularities in returns, trading volume and investor size"National Bureau of Economic Research web site
Why has CEO pay increased so much?
by Xavier Gabaix
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8 editions published in 2006 in English and held by 54 WorldCat member libraries worldwide "This paper develops a simple equilibrium model of CEO pay. CEOs have different talents and are matched to firms in a competitive assignment model. In market equilibrium, a CEO's pay changes one for one with aggregate firm size, while changing much less with the size of his own firm. The model determines the level of CEO pay across firms and over time, offering a benchmark for calibratable corporate finance. The sixfold increase of CEO pay between 1980 and 2003 can be fully attributed to the sixfold increase in market capitalization of large US companies during that period. We find a very small dispersion in CEO talent, which nonetheless justifies large pay differences. The data broadly support the model. The size of large firms explains many of the patterns in CEO pay, across firms, over time, and between countries"National Bureau of Economic Research web site
The great diversification and its undoing
by Vasco M Carvalho
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8 editions published in 2010 in English and Undetermined and held by 48 WorldCat member libraries worldwide We investigate the hypothesis that macroeconomic fluctuations are primitively the results of many microeconomic shocks, and show that it has significant explanatory power for the evolution of macroeconomic volatility. We define "fundamental" volatility as the volatility that would arise from an economy made entirely of idiosyncratic microeconomic shocks, occurring primitively at the level of sectors or firms. In its empirical construction, motivated by a simple model, the sales share of different sectors vary over time (in a way we directly measure), while the volatility of those sectors remains constant. We find that fundamental volatility accounts for the swings in macroeconomic volatility in the US and the other major world economies in the past half century. It accounts for the "great moderation" and its undoing. Controlling for our measure of fundamental volatility, there is no break in output volatility. The initial great moderation is due to a decreasing share of manufacturing between 1975 and 1985. The recent rise of macroeconomic volatility is due to the increase of the size of the financial sector. We provide a model to think quantitatively about the large comovement generated by idiosyncratic shocks. As the origin of aggregate shocks can be traced to identifiable microeconomic shocks, we may better understand the origins of aggregate fluctuations
Limits of arbitrage : theory and evidence from the mortgagebacked securities market
by Xavier Gabaix
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7 editions published in 2005 in English and held by 46 WorldCat member libraries worldwide Limits of Arbitrage" theories hypothesize that the marginal investor in a particular asset market is a specialized arbitrageur rather than a diversified representative investor. We examine the mortgagebacked securities (MBS) market in this light. We show that the risk of homeowner prepayment, which is a wash in the aggregate, is priced in the MBS market. The covariance of prepayment risk with aggregate wealth implies the wrong sign to match the observed prices of prepayment risk. The price of risk is better explained by a kernel based on MBSmarketwide specific risk. This finding is consistent with the specialized arbitrageur hypothesis
Boundedly rational dynamic programming some preliminary results
by Xavier Gabaix
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11 editions published in 2012 in English and held by 44 WorldCat member libraries worldwide A key open question in economics is the practical, portable modeling of bounded rationality. In this short note, I report ongoing progress that is more fully developed elsewhere. I present some results from a new model in which the decisionmaker builds a simplified representation of the world. The model allows to model boundedly rational dynamic programming in a parsimonious and quite tractable way. I illustrate the approach via a boundedly rational version of the consumptionsaving life cycle problem. The consumer can pay attention to the variables such as the interest rate and his income, or replace them, in his mental model, by their average values. Endogenously, the consumer pays little attention to interest rate but pays keen attention to his income. One consequence of this is that Euler equations will be biased, and the intertemporal elasticity of substitution will be biased toward 0, in a manner that is quantitatively important
Linearitygenerating processes a modeling tool yielding closed forms for asset prices
by Xavier Gabaix
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5 editions published in 2007 in English and held by 43 WorldCat member libraries worldwide This methodological paper presents a class of stochastic processes with appealing properties for theoretical or empirical work in finance and macroeconomics, the "linearitygenerating" class. Its key property is that it yields simple exact closedform expressions for stocks and bonds, with an arbitrary number of factors. It operates in discrete and continuous time. It has a number of economic modeling applications. These include macroeconomic situations with changing trend growth rates, or stochastic probability of disaster, asset pricing with stochastic risk premia or stochastic dividend growth rates, and yield curve analysis that allows flexibility and transparency. Many research questions may be addressed more simply and in closed form by using the linearitygenerating class
Tractability in incentive contracting
by Alex Edmans
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10 editions published between 2009 and 2010 in English and held by 43 WorldCat member libraries worldwide "This paper identifies a class of multiperiod agency problems in which the optimal contract is tractable (attainable in closed form). By modeling the noise before the action in each period, we force the contract to provide sufficient incentives statebystate, rather than merely on average. This tightly constrains the set of admissible contracts and allows for a simple solution to the contracting problem. Our results continue to hold in continuous time, where noise and actions are simultaneous. We thus extend the tractable contracts of Holmstrom and Milgrom (1987) to settings that do not require exponential utility, a pecuniary cost of effort, Gaussian noise or continuous time. The contract's functional form is independent of the noise distribution. Moreover, if the cost of effort is pecuniary (multiplicative), the contract is linear (loglinear) in output and its slope is independent of the noise distribution, utility function and reservation utility. In a twostage contracting game, the optimal target action depends on the costs and benefits of the environment, but is independent of the noise realization."National Bureau of Economic Research web site
Variable rare disasters an exactly solved framework for ten puzzles in macrofinance
by Xavier Gabaix
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5 editions published in 2008 in English and held by 42 WorldCat member libraries worldwide This paper incorporates a timevarying intensity of disasters in the RietzBarro hypothesis that risk premia result from the possibility of rare, large disasters. During a disaster, an asset's fundamental value falls by a timevarying amount. This in turn generates timevarying risk premia and thus volatile asset prices and return predictability. Using the recent technique of linearitygenerating processes (Gabaix 2007), the model is tractable, and all prices are exactly solved in closed form. In the "variable rare disasters" framework, the following empirical regularities can be understood qualitatively: (i) equity premium puzzle (ii) riskfree ratepuzzle (iii) excess volatility puzzle (iv) predictability of aggregate stock market returns with pricedividend ratios (v) value premium (vi) often greater explanatory power of characteristics than covariances for asset returns (vii) upward sloping nominal yield curve (viiii) a steep yield curve predicts high bond excess returns and a fall in long term rates (ix) corporate bond spread puzzle (x) high price of deep outofthemoney puts. I also provide a calibration in which those puzzles can be understood quantitatively as well. The fear of disaster can be interpreted literally, or can be viewed as a tractable way to model timevarying riskaversion or investor sentiment
Risk and the CEO market Why do some large firms hire highlypaid, lowtalent ceos?
by Alex Edmans
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11 editions published in 2010 in English and held by 41 WorldCat member libraries worldwide "This paper presents a market equilibrium model of CEO assignment, pay and incentives under risk aversion and heterogeneous moral hazard. Each of the three outcomes can be summarized by a single closedform equation. In assignment models without moral hazard, allocation depends only on firm size and the equilibrium is efficient. Here, talent assignment is distorted by the agency problem as firms involving higher risk or disutility choose less talented CEOs. Such firms also pay higher salaries in the crosssection, but economywide increases in risk or the disutility of being a CEO (e.g. due to regulation) do not affect pay. The strength of incentives depends only on the disutility of effort and is independent of risk and risk aversion. If the CEO affects the volatility as well as mean of firm returns, incentives rise and are increasing in risk and risk aversion. We calibrate the efficiency losses from various forms of poor corporate governance, such as failures in monitoring and inefficiencies in CEO assignment. The losses from misallocation of talent are orders of magnitude higher than from inefficient risksharing"National Bureau of Economic Research web site
Rare disasters and exchange rates
by Emmanuel Farhi
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5 editions published in 2008 in English and held by 39 WorldCat member libraries worldwide We propose a new model of exchange rates, which yields a theory of the forward premium puzzle. Our explanation combines two ingredients: the possibility of rare economic disasters, and an asset view of the exchange rate. Our model is frictionless, has complete markets, and works for an arbitrary number of countries. In the model, rare worldwide disasters can occur and affect each country's productivity. Each country's exposure to disaster risk varies over time according to a meanreverting process. Risky countries command high risk premia: they feature a depreciated exchange rate and a high interest rate. As their risk premium mean reverts, their exchange rate appreciates. Therefore, currencies of high interest rate countries appreciate on average. To make the notion of disaster risk more implementable, we show how options prices might in principle uncover latent disaster risk, and help forecast exchange rate movements. We then extend the framework to incorporate two factors: a disaster risk factor, and a business cycle factor. We calibrate the model and obtain quantitatively realistic values for the volatility of the exchange rate, the forward premium puzzle regression coefficients, and nearrandom walk exchange rate dynamics. Finally, we solve a model of stock markets across countries, which yields a series of predictions about the joint behavior of exchange rates, bonds, options and stocks across countries. The evidence from the options market appears to be supportive of the model
The granular origins of aggregate fluctuations
by Xavier Gabaix
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5 editions published in 2009 in English and held by 39 WorldCat member libraries worldwide This paper proposes that idiosyncratic firmlevel fluctuations can explain an important part of aggregate shocks, and provide a microfoundation for aggregate productivity shocks. Existing research has focused on using aggregate shocks to explain business cycles, arguing that individual firm shocks average out in aggregate. I show that this argument breaks down if the distribution of firm sizes is fattailed, as documented empirically. The idiosyncratic movements of the largest 100 firms in the US appear to explain about one third of variations in output and the Solow residual. This "granular" hypothesis suggests new directions for macroeconomic research, in particular that macroeconomic questions can be clarified by looking at the behavior of large firms. This paper's ideas and analytical results may also be useful to think about the fluctuations of other economic aggregates, such as exports or the trade balance
A sparsitybased model of bounded rationality
by Xavier Gabaix
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4 editions published in 2011 in English and held by 38 WorldCat member libraries worldwide This paper proposes a model in which the decision maker builds an optimally simplified representation of the world which is "sparse," i.e., uses few parameters that are nonzero. Sparsity is formulated so as to lead to wellbehaved, convex maximization problems. The agent's choice of a representation of the world features a quadratic proxy for the benefits of thinking and a linear formulation for the costs of thinking. The agent then picks the optimal action given his representation of the world. This model yields a tractable procedure, which embeds the traditional rational agent as a particular case, and can be used for analyzing classic economic questions under bounded rationality. For instance, the paper studies how boundedly rational agents select a consumption bundle while paying imperfect attention to prices, and how frictionless firms set prices optimally in response. This leads to a novel mechanism for price rigidity. The model is also used to examine boundedly rational intertemporal consumption problems and portfolio choice with imperfect understanding of returns
Power laws in economics and finance
by Xavier Gabaix
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6 editions published in 2008 in English and held by 37 WorldCat member libraries worldwide A power law is the form taken by a large number of surprising empirical regularities in economics and finance. This article surveys welldocumented empirical power laws concerning income and wealth, the size of cities and firms, stock market returns, trading volume, international trade, and executive pay. It reviews detailindependent theoretical motivations that make sharp predictions concerning the existence and coefficients of power laws, without requiring delicate tuning of model parameters. These theoretical mechanisms include random growth, optimization, and the economics of superstars coupled with extreme value theory. Some of the empirical regularities currently lack an appropriate explanation. This article highlights these open areas for future research
Rank1/2 a Simple Way to Improve the OLS Estimation of Tail Exponents
by Xavier Gabaix
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5 editions published in 2007 in English and held by 33 WorldCat member libraries worldwide "Despite the availability of more sophisticated methods, a popular way to estimate a Pareto exponent is still to run an OLS regression: log(Rank)=ab log(Size), and take b as an estimate of the Pareto exponent. The reason for this popularity is arguably the simplicity and robustness of this method. Unfortunately, this procedure is strongly biased in small samples. We provide a simple practical remedy for this bias, and propose that, if one wants to use an OLS regression, one should use the Rank1/2, and run log(Rank1/2)=ab log(Size). The shift of 1/2 is optimal, and reduces the bias to a leading order. The standard error on the Pareto exponent zeta is not the OLS standard error, but is asymptotically (2/n)^(1/2) zeta. Numerical results demonstrate the advantage of the proposed approach over the standard OLS estimation procedures and indicate that it performs well under dependent heavytailed processes exhibiting deviations from power laws. The estimation procedures considered are illustrated using an empirical application to Zipf's law for the U.S. city size distribution"National Bureau of Economic Research web site
CEO pay and firm size an update after the crisis
by Xavier Gabaix
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6 editions published in 2013 in English and held by 29 WorldCat member libraries worldwide In the "size of stakes" view quantitatively formalized in Gabaix and Landier (2008), CEO compensation is determined in a competitive talent market, and reflects the size of firms affected by talent. This paper offers an empirical update on this view. The years 20042011, which include the recent crisis, were not part of the initial study and offer a laboratory to examine the theory as they include new positive and negative shocks to the size of large firms. Executive compensation at the top (ex ante) did closely track the evolution of average firm value during those years. During the crisis (2007  2009), average total firm value decreased by 17%, and CEO pay decreased by 28%. During 20092011, we observe a rebound of firm value by 19% and of CEO pay increased by 22%. These fairly proportional changes provide a validity check in favor of the "size of stakes" view
La protection du consommateur : rationalité limitée et régulation
by France
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3 editions published in 2012 in French and held by 28 WorldCat member libraries worldwide
A calibrative model of optimal CEO incentives in market equilibrium
by Alex Edmans
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2 editions published in 2007 in English and held by 23 WorldCat member libraries worldwide "This paper presents a unified framework for understanding the determinants of both CEO incentives and total pay levels in competitive market equilibrium. It embeds a modified principalagent problem into a talent assignment model to endogenize both elements of compensation. The model's closed form solutions yield testable predictions for how incentives should vary across firms under optimal contracting. In particular, our calibrations show that the negative relationship between the CEO's effective equity stake and firm size is quantitatively consistent with efficiency and need not reflect rent extraction. Our model and data both also imply that the dollar change in wealth for a percentage change in firm value, scaled by annual pay, is independent of firm size. This may render it an attractive incentive measure as it is comparable between firms and over time. The theory also predicts a positive relationship between pay volatility and firm volatility, and that risk and effort affect total pay along the crosssection but not in the aggregate. Finally, we demonstrate that incentive compensation is effective at solving large agency problems, such as selecting corporate strategy, but smaller issues such as perk consumption are best addressed through direct monitoring"National Bureau of Economic Research web site
A calibratable model of optimal CEO incentives in market equilibrium
by Alex Edmans
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5 editions published in 2007 in English and held by 21 WorldCat member libraries worldwide This paper presents a unified framework for understanding the determinants of both CEO incentives and total pay levels in competitive market equilibrium. It embeds a modified principalagent problem into a talent assignment model to endogenize both elements of compensation. The model's closed form solutions yield testable predictions for how incentives should vary across firms under optimal contracting. In particular, our calibrations show that the negative relationship between the CEO's effective equity stake and firm size is quantitatively consistent with efficiency and need not reflect rent extraction. Our model and data both also imply that the dollar change in wealth for a percentage change in firm value, scaled by annual pay, is independent of firm size. This may render it an attractive incentive measure as it is comparable between firms and over time. The theory also predicts a positive relationship between pay volatility and firm volatility, and that risk and effort affect total pay along the crosssection but not in the aggregate. Finally, we demonstrate that incentive compensation is effective at solving large agency problems, such as selecting corporate strategy, but smaller issues such as perk consumption are best addressed through direct monitoring
The age of reason financial decisions over the lifecycle
by Sumit Agarwal
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5 editions published in 2007 in English and held by 13 WorldCat member libraries worldwide "The sophistication of financial decisions varies with age: middleaged adults borrow at lower interest rates and pay fewer fees compared to both younger and older adults. We document this pattern in ten financial markets. The measured effects cannot be explained by observed risk characteristics. The sophistication of financial choices peaks around age 53 in our crosssectional data. Our results are consistent with the hypothesis that financial sophistication rises and then falls with age, although the patterns that we observe represent a mix of age effects and cohort effects."Abstract in publisher's website more
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Gabaix, X.
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