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Linearity-Generating Processes: A Modelling Tool Yielding Closed Forms for Asset Prices & Why has CEO pay increased so much?

Date: 02-19-2007
Start Time: 6:00pm
End Time: 7:30pm
Speaker: Xavier Gabaix, MIT
Location: 417 International Affairs Building, Altschul Auditorium

ABSTRACT

Paper 1: http://econ-www.mit.edu/faculty/download_pdf.php?id=1371

This methodological paper proposes a new class of stochastic processes with appealing properties for theoretical or empirical work in finance and macroeconomics, the "linearity-generating" class. Its key property is that it yields simple exact closed-form expressions for stocks and bonds, with an arbitrary number of factors, feats that are not possible with the hitherto available modelling methods. It operates in discrete and continuous time. It has a number of economic modeling applications. These include macroeconomic situations with changing trend growth rates, or stochastic probability of disaster, asset pricing with stochastic risk premia or stochastic dividend growth rates, and yield curve analysis that allows flexibility and transparency. Many research questions may be addressed more simply and in closed form by using the linearity-generating class.

Paper 2: http://econ-www.mit.edu/faculty/download_pdf.php?id=1293

This paper develops a simple equilibrium model of CEO pay. CEOs have different talents and are matched to firms in a competitive assignment model. In market equilibrium, a CEO's pay changes one for one with aggregate firm size, while changing much less with the size of his own firm. The model determines the level of CEO pay across firms and over time, offering a benchmark for calibratable corporate finance. The six-fold increase of CEO pay between 1980 and 2003 can be fully attributed to the six-fold increase in market capitalization of large US companies during that period. We find a very small dispersion in CEO talent, which nonetheless justifies large pay differences. The data broadly support the model. The size of large firms explains many of the patterns in CEO pay, across firms, over time, and between countries.

BIO

Xavier Gabaix is the Rudi Dornbusch Associate Professor of Economics at MIT. He obtained his PhD in economics from Harvard University. His research focuses on the finance, macroeconomics, and psychological determinants of seemingly irrational economic behavior. His research has been published in many journals, including the the Journal of Finance, the American Economic Review, Quarterly Journal of Economics and Nature. He received numerous awards and is a Fellow of the National Bureau of Economic Research.

http://econ-www.mit.edu/faculty/index.htm?prof_id=xgabaix&type=paper