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Market Design: Theory and Applications in Development

Periodic Reporting for period 2 - Market Design (Market Design: Theory and Applications in Development)

Reporting period: 2018-02-01 to 2019-07-31

There are two components to my research plan.

First is the study of dynamic markets for real and financial assets in which traders might have asymmetric information. In particular I aim to understand how different characteristics of the market such as frequency of trade and transparency affect the efficiency with which these markets operate. This is a stepping stone to then be able to understand how these markets can be designed or regulated to improve their efficiency. Allowing for competition among market places can also indicate if the best way to intervene in these markets is by fostering competition or if direct government intervention is called for.

Second, market imperfections are exacerbated in developing countries due to the poor rule of law and poor institutional framework. Thus, important welfare gains can potentially be achieved by mitigating these imperfections and fostering the development of markets. I plan to work on these issues by combining theoretical analysis with controlled randomized trials to validate the theoretical insights in the field. For example there are many durable goods such as solar lights that would greatly enhance the welfare of poor rural households. These markets have been very slow to develop due to the lack of credit of final consumers and uncertainty about product quality. By properly designing the self-enforcing agreements between the producers of these goods and the retailers we can ensure retailers get access to financing from the producers. In turn this would allow retailers to extend financing to final consumers. Work on the field will surely uncover other frictions which we can study theoretically how to overcome and again test in the field with further controlled randomized trials.

During these 30 months I have been working quite intensively on both sides of my project with mostly theoretical work on the first part and field experiments for the second.

I provide below some more detail of the worked conducted but in summary I have now completed 4 theoretical papers related to the first part one which already got published in the top journal in economics. Two more papers have been accepted for publication but have not yet been published. We have also finished our first field experiment in Uganda. We are now making some final edits to the paper and will submit it for review in the near future. I have also hired my first post-doc Jaime Millan with whom I have been working hard to finish all of the preparations to launch our second field experiment looking at repeated lending. This project had a big setback since our partners in Sierra Leone abandoned us after two years of work and we have been forced to look for a new partner. Fortunately after a long search we have established a good relationship with a bank in Bolivia and will carry out our experiment there. This can have an important effect in extending the access to credit of previously excluded individuals.
These have been an exciting 30 months.

* One of the papers: Information Spillovers in Asset Markets with Correlated Values, was published in the top economics journal, the American Economic Review.

* I have been invited to present different parts of the project at several important conferences and seminars around the world.

* We have finished the draft of the paper Optimal Arrangements for Distribution in Developing Markets: Theory and Evidence.

* I have updated drafts of 3 working papers:

1) Costs and Benefits of Dynamic Trading in a Lemons Market ( now forthcoming in the Review of Economic Dynamics, a top field journal)

2) From Equals to Despots: The Dynamics of Repeated Group Decision Taking with Private Information (now forthcoming in Journal of Economic Theory, a top field journal)

3) Sentiment Liquidity and Asset Prices. ( Revise and Resubmit request from the American Economic Review)

I have hired and trained Jaime Millan to help with the field experiment in Sierra Leone. We have obtained Human Subjects approval for the experiment both from UC Berkeley and UC3M. We have designed most of the protocols and surveys and have started pilot testing them in the field.
By the end of the project we hope two have finished 5 or 6 theoretical papers providing important contributions to dynamic models of trade with adverse selection. This is an important field that has gained a lot of attention since the financial crisis has highlighted the importance of incentives and adverse selection in financial markets. Our models should provide guidance to policymakers regarding the challenges of regulating these markets. Among our novel contributions we can highlight:

1) A better understanding of how traders of assets with correlated payoffs might coordinate on different equilibria some with implications for trade volume and welfare.

2) How transparency of trading information might in some cases be welfare enhancing while in others not.

3) How trading data from decentralized trades aggregates (o fails to aggregate) relevant information about the state of the economy.

4) That providing traders with information from past trades, for example by introducing benchmarks based on those past trades, might actually change the information content of those past trades.

5) Providing a novel model that shows how market sentiments, asset liquidity and prices are jointly determined. Highlighting how these sentiments might generate aggregate volatility and that this volatility might be a necessary feature of equilibria.

I also expect to have one or two papers highlighting problems with lack of enforcement. In the first paper, which is close to completion, we show how different empirical facts, both at the firm and macroeconomic level can be rationalized by a model with persistent shocks to productivity and weak enforceability of contracts.

In addition we should have one field experiment finished and 3 close to being completed. These experiments are by design long term and in addition the delays we have suffered will imply some of the projects will still be underway when the grant period finishes. Our findings should help guide firms and NGO on how to most effectively overcome the market frictions to successfully increase access to credit and adoption of new products.