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Enterprise Dynamics and Finance: Distinguishing Mechanism Design from Exogenously Incomplete Markets Models

  • Robert M. Townsend

    (University of Chicago)

  • Alexander Karaivanov

    (Simon Fraser University)

We formulate and solve a range of dynamic models of information-constrained credit markets that allow for moral hazard and unobservable investment. We compare them to the exogenously incomplete markets environments of autarky, saving only, and borrowing and lending in a single asset. We use computational methods based on mechanism design theory, linear programming, and maximum likelihood techniques to structurally estimate, compare and statistically distinguish among the competing theoretical models of credit market imperfections. Our methods can be applied with both cross-sectional and panel data and allow for measurement error and unobserved heterogeneity in initial conditions. The models match major stylized facts from the empirical literature on firm dynamics. We find that using consumption, cashflow and investment data jointly or using dynamic data improves the researcher's ability to distinguish across the various model regimes relative to using consumption or investment only data, especially in the presence of high measurement error. We also estimate our models using data on Thai households running small businesses. We find that the borrowing and saving only regimes provide the best fit when using joint data on consumption, cashflow and investment.

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Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 846.

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Date of creation: 2008
Date of revision:
Handle: RePEc:red:sed008:846
Contact details of provider: Postal: Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA
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  1. Marco Cagetti & Mariacristina De Nardi, 2005. "Wealth inequality: data and models," Working Paper Series WP-05-10, Federal Reserve Bank of Chicago.
  2. Abraham, Arpad & Pavoni, Nicola, 2004. "Efficient Allocations with Moral Hazard and Hidden Borrowing and Lending," Working Papers 04-05, Duke University, Department of Economics.
  3. Lehnert, Andreas & Ligon, Ethan & Townsend, Robert M., 1999. "Liquidity Constraints And Incentive Contracts," Macroeconomic Dynamics, Cambridge University Press, vol. 3(01), pages 1-47, March.
  4. Matthias Doepke & Robert M. Townsend, 2002. "Dynamic Mechanism Design With Hidden Income and Hidden Actions," UCLA Economics Working Papers 818, UCLA Department of Economics.
  5. Anna L. Paulson & Robert M. Townsend & Alexander Karaivanov, 2006. "Distinguishing Limited Liability from Moral Hazard in a Model of Entrepreneurship," Journal of Political Economy, University of Chicago Press, vol. 114(1), pages 100-144, February.
  6. Karaivanov, Alexander, 2012. "Financial constraints and occupational choice in Thai villages," Journal of Development Economics, Elsevier, vol. 97(2), pages 201-220.
  7. Vuong, Quang H, 1989. "Likelihood Ratio Tests for Model Selection and Non-nested Hypotheses," Econometrica, Econometric Society, vol. 57(2), pages 307-33, March.
  8. Paulson, Anna L. & Townsend, Robert, 2004. "Entrepreneurship and financial constraints in Thailand," Journal of Corporate Finance, Elsevier, vol. 10(2), pages 229-262, March.
  9. Gine, Xavier, 2005. "Access to capital in rural Thailand : an estimated model of formal versus informal credit," Policy Research Working Paper Series 3502, The World Bank.
  10. Orazio Attanasio & Nicola Pavoni, 2004. "Testing Private Information Models with Asset Accumulation," 2004 Meeting Papers 436, Society for Economic Dynamics.
  11. Ana Fernandes & Christopher Phelan, 1999. "A recursive formulation for repeated agency with history dependence," Staff Report 259, Federal Reserve Bank of Minneapolis.
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