Highlights 2014

WP 13/14

Contrary to the long held view that, in terms of rehabilitation of inmates, “nothing works”, Daniele Terlizzese, with Giovanni Mastrobuoni in “Harsh or Humane? Detention Conditions and Recidivism” show that prison conditions respectful of human dignity and guaranteeing a productive use of time – as offered by the “open-cell” prison of Bollate (near Milan) – significantly reduce recidivism. As inmates are not randomly sent to Bollate, the authors deal with the issue of selection by exploiting the random components of the length of the period spent at Bollate. Their most stringent test restricts the analysis to inmates who are displaced to Bollate at the same time and from the same prison, due to overcrowding of the prison of origin, controlling for a measure of potential selection based on a revealed preferences argument. Spending one more year at Bollate (and one less year at an ordinary prison) reduces recidivism by around 10 percentage points. For the group of displaced inmates, who is shown to be negatively selected, the effects of rehabilitation efforts on recidivism are larger. While a longer spell at Bollate is likely to improve the chances of finding a job once released from prison, this is not the only driver of the estimated reduction in recidivism. Prison conditions which do not infringe human dignity and which offer meaningful occupational activity and treatment programs to inmates, to quote from a recommendation of Council of Europe, in and of themselves seem to play a relevant role.

WP 12/14

Economic models assuming that individuals’ risk preferences are invariant over time are unable to account for the large fluctuations observed in the prices of risky assets, in particular in the wake of a financial crisis. For this reason, the hypothesis that attitudes towards risks are constant has been abandoned by economists. In “Risk Aversion and Financial Crisis” Luigi Guiso summarizes the state of the art of recent literature trying to explain why willingness to bear risk may vary over time, both at aggregate and individual level, focusing on the approaches studying the variation of single investors’ risk aversion. A first approach has found a correlation between the level of risk tolerance and age (adults are usually more risk averse than young) and showed that the latter may explain trends in aggregate risk aversion if the age-distribution of the population changes, but per se cannot explain fluctuations in risk attitudes over the business cycles. A second approach has investigated the relationship between emotions (such as mood, fear and anger) and the degree of risk tolerance and has shown that changes in emotions, induced by catastrophic events (traumas), either economic or non-economic, can lead to a significant decrease in the willingness to bear risk. As long as a financial crisis represents a traumatic experience for many, it can induce large upward swings in risk aversion and, most importantly, this effect can last long, thus explaining why recoveries after a financial crisis are so slow. Finally, by using direct measures of risk aversion elicited in surveys or even in experiments, recent empirical research documents a dramatic increase of individuals’ risk aversion after the 2008 financial crisis, which can be ascribed to both economic and psychological factors.

WP 11/14

In “Optimal Life Cycle Unemployment Insurance” Claudio Michelacci, with Hernán Ruffo, argue that US welfare would rise if unemployment insurance were increased for younger workers and decreased for older ones. This is because young unemployed workers suffer large consumption losses upon unemployment, and respond little to changes in unemployment benefits. So unemployment insurance is most valuable to them, while moral hazard is mild. By calibrating a life cycle model with unemployment risk and endogenous search effort, the authors find that, under the optimal age-dependent policy, income replacement rates should increase from the current level of 50 per cent to around 80 per cent for workers in their mid-twenties and to 60 per cent for workers in their thirties. Workers in their forties and fifties, instead, should get benefits of less than 10 per cent of their last wages. Allowing unemployment benefit replacement rates and other government transfers to decline with age yields sizeable welfare gains amounting to around 90 per cent of the gains attained under the unconstrained optimal scheme for unemployment insurance over the life cycle. Around a quarter of these gains are due to age-dependent unemployment benefits.

WP 10/14

In “Labor Supply with Job Assignment under Balanced Growth” Claudio Michelacci, with Joseph Pijoan-Mas, analyze labor supply decisions in a model with balanced growth in which technological progress is embodied into new jobs that are slowly created over time. Workers differ in skills and can be employed in at most one job. In every period each worker decides whether to actively participate in the labor market, and how many hours to work in the job he is assigned to. As lower skilled workers can supply more hours, in equilibrium higher skilled workers are assigned to better jobs only if differences in consumption are small related to those in workers’ skills. The model endogenously generates inequality in jobs, wages, and labor supply, but all workers of the same skill consume the same amount. When the pace of technological progress accelerates, differences in job technologies widen, wage inequality increases and workers participate less often in the labor market but supply more hours in the job. The paper shows that this mechanism can quantitatively account for both the decline of labor force participation of male workers of different skills and the increase of their working hours observed in the US since the 70’s in the wake of the increase in male wage inequality.

WP 09/14

In “Unhealthy Retirement?” Franco Peracchi, with Fabrizio Mazzonna, investigate the causal effect of retirement on health and cognitive abilities. In order to do so, they exploit the panel dimension of the first two waves of the Survey of Health Ageing and Retirement in Europe (SHARE) and the variation between and within 10 European countries of retirement rules. The results suggest a negative effect of retirement on health and cognitive abilities for the population as a whole which increases with the number of years spent in retirement. However, this negative effect disappears when the authors focus on people who work or used to work in more physically demanding occupations. For these people, retirement has an immediate beneficial effect on both health and cognitive abilities. These results suggest that the design of pension reform should take care of the relatively small fraction of workers in very physically demanding occupations.

WP 08/14

In “Static and Dynamic Networks in Interbank Markets”, Eleonora Patacchini, with E. Cohen-Cole and Y. Zenou, model systemic risk in the interbank market as the propagation of incentives or strategic behavior rather than that of losses after default, as common in the existing literature. In their model shock-transmission is not based on default. Instead, bank profitability is based on competition incentives and is the outcome of a strategic game. As competitors’ lending decisions change, banks adjust their own decisions, thus generating a shock-transmission through the system. The authors provide a unique equilibrium characterization of a static model which is embedded into a complete dynamic model of network formation. They also derive an exact formula for the “key bank”, i.e. the bank which, once removed from the network, reduces the total amounts of loans the most. This formula can help a regulatory authority to decide which bank should be bailed should a financial crisis develop.

WP 07/14

In “Identification and Estimation of Outcome Response with Heterogeneous Treatment Externalities”, Eleonora Patacchini, with T. Arduini and E. Rainone, study the identification and estimation of treatment response with heterogeneous spillovers in a network model. In the paper heterogeneity is that generated when the diffusion of the treatment effect induces different individual responses due to both differences in interaction strengths within and between groups and to the network structure. The authors generalize the standard Manski-type linear-in-means model to allow for both within and between-group interactions. They provide a set of identification conditions of peer effects and propose a 2SLS estimation approach. Moreover, after deriving large sample properties of the estimators, they show, by means of simulation experiments, that the estimators perform well in finite samples. The methodology is then applied to analyze the effectiveness of policies where peer effects can act as a mechanism through which the treatment propagates through networks. When interactions among groups are at work, a shock on a treated group has effects on the non-treated ones. Monte Carlo simulations show that the presence of heterogeneous peer effects may lead to unexpected, or sometimes paradoxical results if the policy maker ignores them. These results help to explain why several policy programs failed to reach the expected goals.

WP 06/14
In “Endogenous Network Production Functions with Selectivity”, Eleonora Patacchini, with W.C. Horrace and X. Liu, set up a network production function model incorporating peer effects on output. A salient feature is that a manager places workers into teams (networks) to produce output for a specific project. This set up allows to tackle endogeneity issues arising from selection into groups and exposure to common group factors by employing a polychotomous Heckman-type selection correction. The authors apply this methodology to data from the Syracuse University men’s college basketball team where at any point in time the coach selects a lineup and the players interact strategically to win games. The results show that, once selectivity bias is taken into account, a one unit increase in the average efficiency of the other guards (forwards) induces a 0.0534 increase in the efficiency of an individual guard (forward).

WP 05/14
In “Growing up in wartime: Evidence from the era of two World Wars”, Franco Peracchi, with Enkelejda Havari, empirically investigate the long-term consequences of war on the health and human capital of Europeans born during the first half of the twentieth century, the so called “era of two World Wars”. This period also includes the Spanish Flu episode and a series of armed conflicts which foreshadowed or followed the two World Wars. First of all, the authors find that mortality rates are much higher in war afflicted than non-war afflicted countries during the two World Wars, but not during the Spanish Flu. Moreover there are relevant differences in the mortality patterns by gender and age between the first and second world war. Regarding the long-term consequences on the survivors, the paper shows that, while there is little evidence of increased adult mortality for people born during the first and the second world war, some evidence exists for people born during the Spanish Flu, especially in England and Wales, France and Italy. On the other hand, war-related hardship episodes in childhood or adolescence (in particular exposure to war events and hunger) are strong predictors of physical and mental health, education, cognitive ability and well-being after the age of 50. The magnitude of the estimated effects differs by socio-economic status in childhood and gender, with exposure to war events having a larger impact on females and that to hunger on males. Exposure to war events matters more in adolescence, while that to hunger more in childhood. Finally, the long-term consequences of hardship episodes are stronger the longer the episodes last.

WP 04/14

In “The Word on Banking: Social Ties, Trust, and the Adoption of Financial Products”, Eleonora Patacchini (with Edoardo Rainone) exploit a unique data set on friendships among a representative sample of US students to empirically assess the importance of face-to-face peer effects in financial decisions. By applying a novel estimation strategy, which allows to control for possibly endogenous network formation, the authors show that not all social contacts are equally important: only those developed within a long-lasting relationship influence financial decisions. The results are consistent with the hypothesis that when agents have to decide whether or not to adopt a financial instrument they face a risk and might value more the information coming from people with whom they have had repeated interactions over time. These results also corroborate previous finding in finance showing an important role of trust in financial decisions. Moreover they help to understand why, notwithstanding the diffusion of new technologies, face-to-face social contacts remain the preferred channel to acquire information on financial products.

WP 03/14

Jeff Butler (with Joshua Miller), in “Social Risk: the Role of Warmth and Competence”, experimentally investigates how warmth and competence (two factors suggested by the social psychological literature on person perception) affect individuals’ attitudes toward social risk. To this aim the authors set up a simple model incorporating these two factors in the characterization of social-risk attitudes and use it to generate testable hypotheses about how warmth and competence may affect attitudes towards social risk. After replicating the by-now standard betrayal aversion finding according to which individuals may be willing to pay a premium to have outcomes decided by chance rather than a human co-player, the authors go on and show that this need not always be the case. In particular participants may be willing to pay a premium to have outcomes determined by an incompetent opponent rather than by chance. Because not only the magnitude, but also the sign, of the social risk premium may change across situations with identical outcomes, the presence of social risk may give rise to qualitatively different behavior across otherwise-identical choices. For example, when the resolution of uncertainty depends on another (competitive) human’s actions, individuals may appear risk-seeking or risk-averse in an apparently identical environment, depending on the competence of the humans on whom uncertainty depends. As a whole these results suggest that social risk engenders more nuanced attitudes than previously thought.

WP 02/14

In “Employment and Wage Insurance within Firms: Worldwide Evidence”, Andrew Ellul, Marco Pagano and Fabiano Schivardi investigate the determinants of the implicit employment and wage insurance provided by firms to their employees against industry-level and idiosyncratic shocks. The supply of insurance is identified by relying on differences between family and non-family firms’ behaviour, while the demand for insurance by workers is identified with differences among national public insurance programs. The evidence from a large international panel of firm-level data including 41 countries indicates that family firms provide more employment protection than non-family firms, especially in response to transitory shocks, but less wage stability. Moreover family firms offer less job protection in countries whose unemployment insurance is more generous, indicating that firm and government employment insurance are substitutes. The authors also show that the employment protection provided by family firms is priced: their employees earn 5 % less on average, controlling for country, industry and time effects. The cross-country evidence is broadly confirmed by Italian employee-employer matched data.

WP 01/14

Sergei Kovbasyuk and Marco Pagano, in “Advertising Arbitrage”, set up a model where investors who identify mispriced securities (“arbitrageurs”) publicly disclose their private information to accelerate the correction of mispricing. The model has five predictions: i) even when an arbitrageur identifies several mispriced assets, he will concentrate his advertising effort on a single one as focusing the attention of other investors on a single asset will increase the probability of eliminating its mispricing and closing his position profitably; ii) the concentration of advertising activity on a single asset leads to portfolio under-diversification; iii) the intensity of advertising effort is higher the larger is an asset’s initial mispricing, the noisier is public information about it and the more “advertisable” is the asset; iv) the arbitrageurs’ reputation matters: a reputable arbitrageurs may successfully publicize his recommendations even if he does not justify them with hard data; v) strategic complementarity induces arbitrageurs to invest in the same asset and advertise it; this choice may be inefficient as arbitrageurs might collectively benefit by investing in another asset.

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