Tuesday, August 28, 2007
Off to Jackson Hole on Thursday
Preliminary Syllabus for Finance 397
Applied Microeconomic for Business
Professor Richard K. Green
Office: 507 Funger
Office Hours: 1-3 Tuesday or by Appointment
This is a course in the application of microeconomic theory to academic business disciplines. As such, it is not a traditional graduate microeconomics course, such as Economics 301. All business disciplines—even management and marketing—contain some economic theory in their literatures. For example, papers in marketing are often applications of industrial organization theory, and papers in management often deal with principal-agency and asymmetric information issues.
The class will contain four requirements: two exams (25 percent each), an 8-10 page critical review paper (30 percent), and a 15 minute presentation, such as one would give at an academic meeting (20 percent).
Texts: (*)-ed readings are required.
1. Introduction to Economic Analysis, by R. Preston McAfee, (an open source principles text downloadable from http://www.introecon.com/). (*)
2. Game Theory for Applied Economists, by Robert Gibbons, Princeton University Press (1992, paperback). ISBN 0-691-00395-5. (*)
3. Identification Problems in the Social Sciences, by Charles F. Manski, Harvard University Press, (1995, paperback). ISBN 0-674-44284-9.(*)
Week 1: Introduction to Optimization and the Robinson Crusoe Economy
Week 2: Optimization and Theory of the Firm
McAfee Chapter 4 and 6
Griliches, Zvi and Jacques Mairesse (1995) Production Functions: The Search for
Identication, NBER Working Paper No.w5067.
Week 3: Industrial Organization I
Borenstein, Severin, Hubs and High Fares: Dominance and Market Power in
Week 4: Theory of the Consumer
McAfee Chapter 5
Laurits R. Christensen; Dale W. Jorgenson; Lawrence J. Lau, Transcendental Logarithmic Utility Functions, The American Economic Review, Vol. 65, No. 3. (Jun., 1975), pp. 367-383
Week 5 Industrial Organization II
Zettelmeyer, Florian, Fiona Scott Morton, and Jorge Silva-Risso (2005) Cowboys
or Cowards: Why are Internet Car Prices Lower?
The Quarterly Journal of Economics, Vol. 84, No. 3. (Aug., 1970), pp. 488-500
Week 6 Topics in Game Theory I
Gibbons Chapter 1
McAfee Chapter 7
Week 7 Exam I
Week 8 Topics in Game Theory II
Gibbons Chapter 2
Shapley, L. S. and M. Shubik (1972) The Assignment Game I: The Core, Interna-
tional Journal of Game Theory, 1: 111-130.
Week 9 Adverse Selection
Gibbons Chapters 3 and 4.
Week 10 Moral Hazard
Week 11 Identification I
James J. Heckman (2000) Causal Parameters and Policy Analysis In Economics:
A Twentieth Century Retrospective, The Quarterly Journal of Economics, 115(1),
Week 12 Identification II
Week 13 Student Presentations of Applied Microeconomic Papers (choose from list)
Week 14 Exam II
Papers to choose from for presentation
Avery, Christopher, Mark Glickman, Caroline Hoxby and Andrew Metrick, A Revealed Preference Ranking of US Colleges and Universities, Working Paper.
Borenstein, Severin and Andrea Shepard (1996) Dynamic Pricing in Retail Gasoline
Markets, Rand Journal of Economics, 27(Autumn): 429-51.
Donohue, J.J. and Steven Levitt, The Impact of Legalized Abortion on Crime." Quarterly Journal of Economics, 2001, 116(2), pp. 379-420.
Gandal, Neil, M. Kende and Rafael Rob (2000) The Dynamics of Technological
Adoption in Hardware/Software Systems: The Case of Compact Disk Players, Rand
Journal of Economics, 31(1): 43-61.
Graddy, K. (1995) Testing for Imperfect Competition at the
Rand Journal of Economics, 26 (Spring): 75-92.
Green RK and MJ White, Measuring the Benefits of Homeowning: Effects on Children, Journal of Urban Economics,
Krugman, Paul, Scale Economies, Product Differentiation, and the Pattern of Trade
The American Economic Review, Vol. 70, No. 5. (Dec., 1980), pp. 950-959.
Mankiw, G and D Weil, The Baby Boom, the Baby Bust and the Housing Market, Regional Science and Urban Economics
Monday, August 27, 2007
If you want to be scared about subprime...
The story I heard from a bond trader is that the Chinese were willing to buy paper at very low spreads just to keep the RMB from appreciating. I have no idea whether this is really true, but it makes for a good story.
Sunday, August 26, 2007
Subprime--I was probably wrong
The problem is that borrowers did not understand what the sales people where selling them. Loans are complicated--even the "sticker price," the APR, doesn't really tell the story. And so borrowers, particularly those without any financial training, are at a disticnt disadvantage when dealing with lenders.
I am not sure what to do about this. I have long thought that the sub-prime market could give borrowers access to cheaper credit than they would get elsewhere; nevertheless, the market also led people to make what were clearly bad decisions. I am not sure how reasonable it was to expect borrowers to understand how bad their decisions would turn out to be.
And so we must figure out a mechanism for helping borrowers navigate the mortgage waters better. I am not sure what that is. One possibility: tie loan broker compensation not just to loan origination, but loan performance. They don't get fully paid until the loan is fully paid. This would reduce the incentive for them to make loans that will turn into defaults.
Teaching and Research Again
Wednesday, August 22, 2007
Dhaka's getting worse
When I visited Dhaka in 2004, it was a place of unspeakable poverty, and according to Transparency International, had among the world's worst corruption. But so far as I could tell, people could move, speak and organize reasonably freely. The press was certainly vigorous and regularly criticized the government. It was hardly a paragon of human rights. To me, human rights include the right to have enough to eat and the right of all children to go to school. But among all the world's poor countries, its human rights record was not too bad.
Still, I left Dhaka thinking that life would get better there. It has actually shown itself capable of competing in the textile business in the absence of the multifibre agreement. The people there were also remarkably gracious. I thought there was a chance for corruption to be reduced, and for the middle-class to grow. I hope that I will someday be proved correct, but today I don't have a lot of hope.
Monday, August 20, 2007
How does the NFL get away with charging for the Preseason?
As it happens, a student of mine, Jason Berkowitz, did some regressions of how well the preseason predicted the real season. The answer is that it doesn't--a team's winning percentage in the preseason has almost no predictive power of regular season fortunes.
So the question is--why do fans pay full ticket prices to see these fake games? It is not like spring training in baseball, when going to games in in part an excuse to get away from the cold north. I know this is not the most important issue facing the NFL today, but after watching that game, I just had to wonder....
Tuesday, August 14, 2007
Five year life (stiff prepayment penalties before year five), after which everyone who survives refinances.
Coupon rate starts at 6 for two years, goes to 9 for a year and then 12 for two years.
10 percent default rate over five years with 70 percent loss severity.
Mortgage is tranched into two pieces. Piece A gets the first 80 percent of the equity and a six percent coupon; Piece B gets all the rest.
The IRR on this set up fro the B-piece comes in around 9 percent. Not great, given the risk, but not bad either. It should be enough to pay any leverage taken on to buy it. So...where am I going wrong? I will be happy to share the spreadsheet with anyone who can help me out.
Monday, August 13, 2007
The Jumbo Market and House Prices
But the impact on prices could be serious. Consider what happens when the cost of capital increases quickly by 50 basis points, from 6.5 to 7 percent. The cost of capital has gone up 7.7 percent. But lets say that expectations are for 2 percent house value growth. Then the cap rate for houses goes from 4.5 percent to 5 percent--an 11.1 percent increase. This translates into a ten percent decline in house prices (CF/5)/(CF/4.5) =4.5/5 = .9.
But this phenomenon could change expectations about futue house price expectations. As expectations worsen, the cap rate will rise further, and house prices will fall further. The next few months might be pretty ugly for the coasts.
Wednesday, August 01, 2007
Can Las Vegas Keep Building Apartments?
The answer is: a lot. The basic industry is, of course, accomodation. Las Vegas has around 140,000 hotel rooms (http://cber.unlv.edu/stats.html) with an cccupany rate in excess of 90 percent. Hotels are profitable at occupancy rates of around 65 percent, meaning that Las Vegas could support something like 50,000 more hotel rooms with no increase in demand.
Let's cut that to 25,000 rooms to be conservative. There are roughly two jobs in the hotel business for every room in Las Vegas, meaning that 25,000 rooms will directly create about 50,000 jobs.
Economic base analysis (http://faculty.washington.edu/krumme/350/econbase.html) for Las Vegas predicts that every basic job produces an additional 2.5 non-basic jobs. So the Las Vegas market has room for another 175,000 jobs over the near-to-medium term (say 5 years).
The ratio of jobs to population in Las Vegas is .47; let's round and say population growth produced by hotel room growth will be 350,000. The average Household Size is a little more than 2.5 (census) and about 35 percent of households live in multifamily buildings (again, census). Put this all together, and there will be demand for about 50,000 multi-family units over the medium term--again assuming no growth in demand for hotel rooms. Vacancy rates for apartments in Las Vegas is a little less than 7 percent--this is close to a natural vacancy rate, meaning that the market is currently in equilibrium. The fact that inflation adjusted rents have risen by a bit more than inflation in the past year also indicates that the apartment market is not oversupplied. Assuming hotel developers respond to demand, there should be strong demand for apartments for some years to come.
There are issues, of course, not the least of which is water (although if people would stop watering their lawns, there would be plenty of water for awhile). But it is remarkable how much Las Vegas' strong population growth (and therefore demand for housing construction) is grounded in fundamentals.
A nice mortgage blog by Rhonda Porter