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    Bordalo, Pedro, Nicola Gennaioli, Rafael LaPorta, and Andrei Shleifer. Working Paper. “Expectations of Fundamentals and Stock Market Puzzles”. Abstract

    We revisit several leading puzzles about the aggregate stock market by incorporating into a standard dividend discount model survey expectations of earnings of S&P 500 firms. Using survey expectations, while keeping discount rates constant, explains a significant part of “excess” stock price volatility, price-earnings ratio variation, and return predictability. The evidence is consistent with a mechanism in which good news about fundamentals leads to excessively optimistic forecasts of earnings, especially at long horizons, which inflate stock prices and lead to subsequent low returns. Relaxing rational expectations of fundamentals in a standard asset pricing model accounts for stock market anomalies in a parsimonious way.

    Bordalo, Pedro, Nicola Gennaioli, Andrei Shleifer, and Stephen J. Terry. Working Paper. “Real Credit Cycles”. Abstract
    Recent empirical work has revived the Minsky hypothesis of boom-bust credit cycles driven by uctuations in investor optimism. To quantitatively assess this hypothesis, we incorporate diagnostic expectations into an otherwise standard business cycle model with heterogeneous firms and risky debt. Diagnostic expectations are a psychologically founded, forward-looking model of belief formation that captures over-reaction to news. We calibrate the diagnosticity parameter using microdata on the forecast errors of managers of listed firms in the US. The model generates countercyclical credit spreads and default rates, while the rational expectations version generates the opposite pattern. Diagnostic expectations also offer a good fit of three patterns that have been empirically documented: systematic reversals of credit spreads, systematic reversals of aggregate investment, and predictability of future bond returns. Crucially, diagnostic expectations also generate a strong fragility or sensitivity to small bad news after steady expansions. The rational expectations version of the model can account for the rst pattern but not the others. Diagnostic expectations offer a parsimonious account of major credit cycles facts, underscoring the promise of realistic expectation formation for applied business cycle modeling.
    Bordalo, Pedro, Katherine Coffman, Nicola Gennaioli, Frederik Schwerter, and Andrei Shleifer. 2021. “Memory and Representativeness.” Psychological Review. Abstract

    We explore the idea that judgment by representativeness reflects the workings of episodic memory, especially interference. In a new laboratory experiment on cued recall, participants are shown two groups of images with different distributions of colors. We find that i) decreasing the frequency of a given color in one group significantly increases the recalled frequency of that color in the other group, ii) for a fixed set of images, different cues for the same objective distribution entail different interference patterns and different probabilistic assessments. Selective retrieval and interference may offer a foundation for the representativeness heuristic, but more generally for understanding the formation of probability judgments from experienced statistical associations.

    Gennaioli, Nicola, Rafael LaPorta, Florencio Lopez-de-Silanes, and Andrei Shleifer. Forthcoming. “Trust and Insurance Contracts.” Review of Financial Studies. Abstract

    We assemble and analyze a new data set of homeowner insurance claims from 28 independently operated country subsidiaries of a multinational insurance company. A fundamental feature of the data is that such claims are often disputed, and lead to rejections or lower payments. We propose a new model of insurance, in which consumers can make invalid claims and firms can deny valid claims. In this environment, trust and honesty are critical factors that shape insurance contracts and the payment of claims, especially when the disputed amounts are too small for courts. We characterize equilibrium insurance contracts, and show how they depend on the quality of the legal system and the level of trust. We then investigate the incidence of claims, disputes and rejections of claims, and payment of claims in our data, as well as the cost and pricing of insurance. The evidence is consistent with the centrality of trust for insurance markets, as predicted by the model.

    Behrer, A. Patrick, Edward L. Glaeser, Giacomo A. M. Ponzetto, and Andrei Shleifer. 2021. “Securing Property Rights.” Journal of Political Economy. Abstract

    A central challenge in securing property rights is the subversion of justice through legal skill, bribery, or physical force by the strong—the state or its powerful citizens—against the weak. We present evidence that undue influence on judges is a common concern in many countries, especially among the poor. We then present a model of a water polluter whose discharges contaminate adjacent land. If this polluter can subvert the assessment of damages caused by his activity, there is an efficiency case for granting the landowner the right to an injunction that stops the polluter, rather than the right to compensation for the harm. If the polluter can subvert even the determination of his responsibility for harm, there is an efficiency case for regulation that restricts pollution regardless of its effects. We then conduct an empirical analysis of water quality in the U.S. before and after the Clean Water Act, and show how regulation brought about cleaner water, particularly in states with higher corruption.


    Andrei Shleifer is John L. Loeb Professor of Economics at Harvard University. He holds an undergraduate degree from Harvard and a Ph.D. from MIT. Before coming to Harvard in 1991, he has taught at Princeton and the Chicago Business School. Shleifer has worked in the areas of comparative corporate governance, law and finance, behavioral finance, as well as institutional economics. He has published seven books, including The Grabbing Hand (with Robert Vishny), Inefficient Markets: An Introduction to Behavioral Finance, and A Crisis of Beliefs: Investor Psychology...

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    Shleifer, Andrei, Edward L. Glaesar, Simeon Djankov, and Valeria Perotti. Forthcoming. “Property Rights and Urban Form.” Journal of Law and Economics. Abstract
    How do the different elements in the standard bundle of property rights – such as the right of possession or the right of transfer – differentially impact outcomes, such as urban development? This paper incorporates insecure property rights into a standard model of urban land prices and density, and makes predictions about investment in land and property, informality, and the efficiency of land use. Our empirical analysis links data on institutions related to land titling and transfer with multiple urban outcomes, from 190 countries. The evidence is generally consistent with the model’s predictions, and more broadly with the Demsetz’s (1967) approach to property rights institutions. Indeed, we document world-wide improvements in the quality of institutions facilitating property transfer over time.