nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2009‒01‒17
eleven papers chosen by
Simona Fabrizi
Massey University Department of Commerce

  1. On Reputation: A Microfoundation of Contract Enforcement and Price Rigidity By Fehr, Ernst; Brown, Martin; Zehnder, Christian
  2. The Effect of Rating Agencies on Herd Behaviour By Giovanni Ferri; Andrea Morone
  3. Rational expectations in urban economics By Berliant, Marcus; Yu, Chia-Ming
  4. Indenture as a Self-Enforced Contract Device : An Experimental Test By Alexander S. Kritikos; Jonathan H.W. Tan
  5. Bankruptcy: Is It Enough to Forgive or Must We Also Forget? By Ronel Elul; Piero Gottardi
  6. Satisficing Contracts By Patrick Bolton; Antoine Faure-Grimaud
  7. Fragility of Information Cascades: An Experimental Study using Elicited Beliefs By Frederic Koessler; Anthony Ziegelmeyer; Juergen Bracht; Eyal Winter
  8. Assortative matching through signals By Friedrich Poeschel
  9. Asymmetric information in the interbank foreign exchange market By Geir H. Bjønnes; Carol L. Osler; Dagfinn Rime
  10. Basel II, External Ratings and Adverse Selection By Akhtar, S.; Bannier, C.; Tyrell, M.; Elizalde, A.; Janda, K.; Lind, G.
  11. Non-comparative versus Comparative Advertising as a Quality Signal By Winand Emons; Claude Fluet

  1. By: Fehr, Ernst (University of Zurich); Brown, Martin (Swiss National Bank); Zehnder, Christian (Harvard Business School)
    Abstract: We study the impact of reputational incentives in markets characterized by moral hazard problems. Social preferences have been shown to enhance contract enforcement in these markets, while at the same time generating considerable wage and price rigidity. Reputation powerfully amplifies the positive effects of social preferences on contract enforcement by increasing contract efficiency substantially. This effect is, however, associated with a considerable bilateralisation of market interactions, suggesting that it may aggravate price rigidities. Surprisingly, reputation in fact weakens the wage and price rigidities arising from social preferences. Thus, in markets characterized by moral hazard, reputational incentives unambiguously increase mutually beneficial exchanges, reduce rents, and render markets more responsive to supply and demand shocks.
    Keywords: Reputation; Reciprocity; Relational Contracts; Price Rigidity; Wage Rigidity
    JEL: C90 D82 E24 J30 J41
    Date: 2008–07–01
  2. By: Giovanni Ferri (University of Bari.); Andrea Morone (University of Bari.)
    Abstract: This paper purports to provide some evidence on the effect of rating agencies on herding in financial markets. By means of a laboratory experiment, we investigate the effect and interaction between private and public information. Previous experiments showed that lemmings behaviour can survive in a market context where information is private (Hey and Morone, 2004), and that an experimental market can be very volatile and not efficient in transmitting information (Alfarano et al., 2006). We study experimentally, if socially undesirable behaviour - that survives in a market contest - may be eliminated owing to the presence of rating agencies.
    Keywords: herd behaviour, informational cascades, rating agency, bubble
    JEL: C91 D82 D83
    Date: 2008–11
  3. By: Berliant, Marcus; Yu, Chia-Ming
    Abstract: Canonical analysis of the classical general equilibrium model demonstrates the existence of an open and dense subset of standard economies that possess fully-revealing rational expectations equilibria. This paper shows that the analogous result is not true in urban economies. An open subset of economies where none of the rational expectations equilibria fully reveal private information is found. There are two important pieces. First, there can be information about a location known by a consumer who does not live in that location in equilibrium, and thus the equilibrium rent does not reflect this information. Second, if a consumer’s utility depends only on information about their (endogenous) location of residence, perturbations of utility naturally do not incorporate information about other locations conditional on their location of residence. Existence of a rational expectations equilibrium is proved. Space can prevent housing prices from transmitting information from informed to uninformed households, resulting in an inefficient outcome.
    Keywords: Urban Economics; General Equilibrium; Private Information; Rational Expectations
    JEL: R13 D82 D51
    Date: 2009–01–13
  4. By: Alexander S. Kritikos; Jonathan H.W. Tan
    Abstract: We experimentally test the efficacy of indenture as a self-enforced contract device. In an indenture game, the principal signals the intention of payment-on-delivery, by tearing a banknote and giving the agent half of it as "prepayment"; the agent receives the completing half after delivering the service. By forward induction, cooperation is incentive-compatibly self-enforcing. The indenture performs very well, inducing a significantly higher level of cooperation than that in a three-stage centipede game, which we use to benchmark the natural rate of cooperation. The difference between cooperation rates in both games increases over time.
    Keywords: Cooperation, experiment, contracts, indenture, reciprocity
    JEL: C91 D64 J41
    Date: 2009
  5. By: Ronel Elul; Piero Gottardi
    Abstract: In many countries, lenders are restricted in their access to information about borrowers’ past defaults. We study this provision in a model of repeated borrowing and lending with moral hazard and adverse selection. We analyze its effects on borrowers’ incentives and access to credit, and identify conditions under which it is optimal. We argue that “forgetting” must be the outcome of a regulatory intervention by the government. Our model’s predictions are consistent with the cross-country relationship between credit bureau regulations and provision of credit, as well as the evidence on the impact of these regulations on borrowers’ and lenders’ behavior.
    Keywords: Bankruptcy, Information, Incentives, Fresh Start
    JEL: D86 G33 K35
    Date: 2008
  6. By: Patrick Bolton; Antoine Faure-Grimaud
    Abstract: We propose a model of equilibrium contracting between two agents who are "boundedly rational" in the sense that they face time-costs of deliberating current and future transactions. We show that equilibrium contracts may be incomplete and assign control rights: they may leave some enforceable future transactions unspecified and instead specify which agent has the right to decide these transactions. Control rights allow the controlling agent to defer time-consuming deliberations on those transactions to a later date, making her less inclined to prolong negotiations over an initial incomplete contract. Still, agents tend to resolve conflicts up-front by writing more complete initial contracts. A more complete contract can take the form of either a finer adaptation to future contingencies, or greater coarseness. Either way, conflicts among contracting agents tend to result in excessively complete contracts in the sense that the maximization of joint payoffs would result in less up-front deliberation.
    JEL: C61 D81 D84 D86
    Date: 2009–01
  7. By: Frederic Koessler (Paris School of Economics and CNRS); Anthony Ziegelmeyer (Max Planck Institute for Research into Economic Systems, Strategic Interaction Group, Jena, Germany); Juergen Bracht (University of Aberdeen Business School); Eyal Winter (Center for Rationality and Interactive Decision Theory, Hebrew University of Jerusalem)
    Abstract: This paper examines the occurrence and fragility of information cascades in laboratory experiments. One group of low informed subjects make predictions in sequence. In a matched pairs design, another set of high informed subjects observe the decisions of the first group and make predictions. According to the theory of information cascades (Bikhchandani, Hirshleifer, and Welch, 1992), if initial decisions coincide, an information cascade should occur: it is rational for subsequent players with low quality information to follow the observed pattern regardless of their private information. However, an information cascade should be fragile: it is always rational for subsequent players with high quality information to follow their private information. In line with existing experiments on information cascades, we find some evidence that low informed subjects follow the herd when it is rational, and this herding behavior occurs more frequently if there is a pronounced imbalance. The main finding of this paper is that information cascades are not fragile. We find strong evidence that highly informed subjects follow the herd regardless of their private information. In accordance with those observations we show, by explicitly eliciting subjects' beliefs about the state, that beliefs are not constant in the number of previous decisions that coincide, whether or not an information cascade already occurred. Subjects' behavior can be understood with a statistical model that allows for the possibility of errors in earlier decisions.
    Keywords: Information cascades, elicited beliefs, experimental economics
    JEL: C72 C92 D82
    Date: 2008–12–20
  8. By: Friedrich Poeschel
    Abstract: We model signalling in two-sided sequential search with heterogeneous agents and transferable utility. Search via meetings is time-consuming and thereby costly due to discounting. Search via signals is costless, so that agents can avoid almost all search costs if only the signals are truthful. We show that signals will indeed be truthful if the match output function is su ciently super- modular. The unique separating equilibrium is then characterised by perfect positive assortative matching despite the search frictions. In this equilibrium, agents successfully conclude their search after a single meeting, and overall match output is maximised. These results continue to hold when there are also explicit search costs in addition to discounting.
    Date: 2008
  9. By: Geir H. Bjønnes (Norwegian School of Management (BI),); Carol L. Osler (Brandeis International Business School); Dagfinn Rime (Norges Bank (Central Bank of Norway)and Norwegian University of Science and Technology (NTNU))
    Abstract: This paper provides evidence of private information in the interdealer foreign exchange market. In so doing it provides support for the hypothesis that information is an important reason for the strong positive correlation between order flow and returns. It also provides evidence that information influences order-book structure. Our data comprise the complete record of interdealer trades at a good-sized Scandinavian bank during four weeks in 1998 and 1999, including bank identities. Our results indicate that larger banks have more information than smaller banks, that the relation between order flow and returns is stronger for larger banks than smaller banks, and that larger banks exploit their information advantage in limit-order placement.
    Keywords: Foreign exchange, microstructure, asymmetric information, liquidity premium
    JEL: G15 F31 F33
    Date: 2009–01–08
  10. By: Akhtar, S.; Bannier, C.; Tyrell, M.; Elizalde, A.; Janda, K.; Lind, G.
    Abstract: This paper will describe and analyse the development of Basel II Capital Accord and will focus on the use of external ratings in the Standardized Approach in Basel II. Furthermore it will examine the problem of adverse selection which appears in Basel II as a result from the proposal for the use of external ratings in determining the risk weights in the standardized approach. The paper will also attempt to find possible solutions to the adverse selection problem by discussing two similar models, and derive implications from them.
    Keywords: Basel II; external ratings; adverse selection; rating agencies; standardized approach
    JEL: E51 E5 G24
    Date: 2008–09–30
  11. By: Winand Emons; Claude Fluet
    Abstract: Two firms produce a product with a horizontal and a vertical characteristic. We call the vertical characteristic quality. The difference in the quality levels determines how the firms share the market. Firms know the quality levels, consumers do not. Under non-comparative advertising a firm may signal its own quality. Under comparative advertising firms may signal the quality differential. In both scenarios the firms may attempt to mislead at a cost. If firms advertise, in both scenarios equilibria are revealing. Under comparative advertising the firms never advertise together which they may do under non-comparative advertising.
    Keywords: advertising; costly state falsification; signalling
    JEL: D82 K41 K42
    Date: 2008–12

This nep-cta issue is ©2009 by Simona Fabrizi. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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