Importance of "Relative" Terms rather than "Absolute" Terms

Economics has long been considered only 'absolute' term. In most standard analysis, utility is determined by the level of own consumption and job matching is occurred according to the level of absolute wage. However, in reality, there are many occasions where relative terms play important role as Kahneman and Tversky pointed out. Depending on the reference point, same absolute term can be interpreted differently. If I have so many wealthy friends, then my income as a graduate student is tiny. However, if most of my friends are still in university, my income as graduate student is considerable. That is, if reference point is decided by people around me then important thing is where I stand, not the amount I have.

I went to a talk by Mounir Karadja today and he gave such an interesting story why Sweden can sustain their social welfare system. According to a 2012 OECD report, the country had the second-highest public social spending as a percentage of its GDP after France, which means that this country has one of the most highly developed welfare states. According to his, one of the reasons is that many of people underestimate their relative income. (Relative income here means where you stand in the country's income distribution.) If they are informed their actual relative position and it was higher than their guess, they tend to support conservative party more. That is, Swedish people's guess about relative income could play a role in their political preferences of supporting welfare systems.

Another interesting piece is by Bertrand, Kastenica, and Pan. They discuss the role of social norm "Husband should earn more than wife" on many economic variables such as marriage, labor market participation, divorce rate and satisfaction in the marriage. Here as well what matters is 'relative' income in the household. Relative income here is defined by men's earning divided by women's earning plus men's earning. If this relative income is less than half, then social norm is violated. In this case, marriage rate is decreased, women's labor market participation is decreased (woman don't want to threat her husband), divorce rate is increased and satisfaction in marriage is lower. I enjoyed reading this paper very much not only because I found it interesting to incorporate the role of social norm in economics but also because the way they thought about income distribution in households (i.e.relative income) was interesting.

In sum, I think relative terms are very important in many economic decisions. Below are some references.

"How Elastic are Preferences for Redistribution? Evidence from Randomized Survey Experiments" March 2013 (I. Kuziemko, M. Norton, S. Stantcheva and E. Saez), Revise and Resubmit, American Economic Review (also released as NBER working paper 18865)

"Inequality at Work: The Effect of Peer Salaries on Job Satisfaction." (David Card, Alexandre Mas, Enrico Moretti, and Emmanuel Saez) NBER Working Paper, No. 16396, September 2010.

"Relative income shocks, beliefs and political preferences: Evidence from a randomized survey experiment" (Mounir Karadja et al.)

Cinderella

Cinderella by Christopher Wheeldon was awesome. I believe that people come to the theater to experience a "fantasy". This revived classical fairy tail was enough to awake dormant fantasy. It was the most impressive full act ballet recently. Appropriate sense of humor and beautiful stage were also great. 

Maria Kochetkova... She is so lovely. I was so happy to see her again... I still vividly remember when I first saw her in San Francisco 5 years ago. Small but strong, soft but has a marked character. Beautiful...<3

Career concern 3 (Dasgupta and Prat 2006)

This is another piece of career concern which has an interesting story. :)
Again, like Morris, this paper focuses on a bad result of career concern. (Remember? Holmstrom paper was more about positive side of career concern.)

In financial economics, there is a theorem called "no trade theorem". (what a fancy name!) Roughly speaking, rational agents will not trade with each other on the basis of differences of information alone. If someone tries to sell a stock on the market, then it signals that that seller has a bad information about that asset. Otherwise, why would he sell? Under this rational expectation, there is no trade occuring. The name of the theorem and logic based on information are very graceful, but this does not match with reality. This theorem relies on lots of assumptions so it's like a well controlled lab like experiment which is useful as a benchmark but not a reflection of reality we face. Our question is then: Why we see huge volume of trade in the stock market? What drives people to trade that much?

Many economists tried to answer this question. One explanation is the existence of "noise traders". They trade not because they have some information but because they are in liquidity needs or personal needs such as hedging. But it's hard explain that huge volume of trade by only considering noise traders. Dasgupta and Prat(2006) maintains that career concern of fund managers can help explain huge trade volume. This explanation makes sense because the proportion of institutional investors is getting bigger and bigger. In 2002, 49.8% of ourstanding corporate equity was held by institutional investors. Fund managers may not have information. But if they don't trade because they don't have information, then it becomes an evidence of lack of ability. Just to show that they are not bad, they trade. Trading without information, they lose in expectation in that period, but they can avoid a situation where they are fired because of their incompetency proven by non trade. This drives excessive trade by fund managers. 

In this paper's 2-period model, payment from the investor to the manager is linear function of return(ax+b if x is return). In other words, there is a fixed fee b, and proportional rate a. If a and b are not too big, investors delegate investment to fund managers. Here good fund managers perfectly observe true state of the world and act efficiently, so bad fund manager's behavior becomes a problem. Bad fund managers don't want to be fired in the next period so have an incentive to take a gamble in the first period. (They don't gamble in second period because there is no third period.) If their gamble succeeds (say, 50% probability), they can be retained by the investor. It might fail but at least this is better than do nothing and got fired, if cost of gamble(a) is not too expensive. So if a is not too big, then bad managers take a risk which has negative expected return not to show that they lack information. Thus, parameters a and b are important to predict fund manager's behavior. For example, if b=0 then bad manager has no incentive to trade in the first period by taking dangerous negative expected return gamble.

In addtion to that, signal structure, proportion of good fund managers, existence of contingent contracts matter in predicting the fund manager's behavior. In this paper, there exists only two periods so how career concerns affect fund manager's behavior in the long run (dynamic settings) is an interesting extension. In dynamic setting, it is likely that their true ability is revealed at some point as in Holmstrom. So I guessed if we are lucky, we might have efficient information transmission in the dynamic model. But it seems like we are not lucky enough. Dasgupta and Prat(2008, JET) studied career concern in dynamic setting finance market. I didn't read whole paper, but the conclusion of the paper is that financial market cannot be informationally efficient even in infinite horizon if there is reputational concern.

Reference:
"Financial Equilibrium with Career Concerns" (Amil Dasgupta and Andrea Prat), Theoretical Economics, forthcoming, Volume 1, Issue 1, March 2006.
"Information aggregation in financial markets with career concerns," (Amil Dasgupta and Andrea Prat), Journal of Economic Theory, 143(1): 83-113, November 2008.