FRIC/Finance Seminar with Christopher Hennessy, London Business School

FRIC Center for Financial Frictions and the Department of Finance are proud to announce the upcoming seminar with Christopher Hennessy, London Business School.

Christopher Hennessy will present 

The Paradox of Policy-Relevant RCTs and Natural Experiments

Authors:
Gilles Chemla, Imperial College
Christopher A. Hennessy, London Business School

ABSTRACT
According to conventional wisdom, RCTs and natural experiments represent especially credible bases for econometric inference, facilitating evidence-based policymaking. We assess credibility in dynamic settings, examining robustness of evidence derived from an exogenous first-stage randomization applied to measure zero subjects. If government is able (unable) to alter policy in response, experimental evidence is contaminated (uncontaminated) by ex post endogeneity: Measured responses depend upon the government objective function into which the evidence will be fed. Similarly, if government perceives experimental evidence as credible (non-credible), it is contaminated (uncontaminated) by Hawthorne and John Henry Effects. Thus, paradoxically, the experimental evidence is contaminated if and only if government is willing and able to use it. We show ex post endogeneity causes measured responses to hinge upon (unknown) parameters of the governmental objective function, as well as prior beliefs regarding the causal parameters to be estimated. Moreover, heterogeneous causal effect parameters induce endogenous belief heterogeneity. This link between beliefs and causal parameters makes it difficult, and potentially impossible, to isolate the latter using experimental evidence. Finally, we show measured differences in RCTs are contaminated unless the investment cost function satis.es strong functional form assumptions: zero fixed costs, equality of buy and sell prices, and quadratic adjustment costs.