nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2010‒07‒17
eleven papers chosen by
Simona Fabrizi
Massey University Department of Commerce

  1. Optimal Incentive Contracts under Moral Hazard When the Agent Is Free to Leave By Englmaier, Florian; Muehlheusser, Gerd; Roider, Andreas
  2. Markets and contracts By Alberto Bisin; John Geanakoplos; Piero Gottardi; Enrico Minelli; Herakles Polemarchakis
  3. Equilibrium Asset Pricing And Portfolio Choice Under Asymmetric Information. By Biais, Bruno; Bossaerts, Peter; Spatt, Chester
  4. Optimal Contract Design with Unilateral Market Option By Antonio Nicita; Simone Sepe
  5. Adverse Selection in the Environmental Stewardship Scheme: Evidence in the Higher Level Stewardship Scheme? By Quillérou, Emmanuelle; Fraser, Rob, Prof.; Fraser, Iain, Dr
  6. Biased experts, costly lies, and binary decisions By Roland Hodler; Simon Loertscher; Dominic Rohner
  7. Efficiency and Equilibria in Games of Optimal Derivative Design By Ulrich Horst; Santiago Moreno-Bromberg
  8. Systemic risk in the financial sector; A review and synthesis By Michiel Bijlsma; Jeroen Klomp; Sijmen Duineveld
  9. Credible Deviations from Signaling Equilibria.. By Eső, Péter; Schummer, James
  10. Bailouts in Federations By Kaiser, Karolina
  11. Overreporting Oil Reserves By Sauré, Philip

  1. By: Englmaier, Florian (University of Munich); Muehlheusser, Gerd (University of Bielefeld); Roider, Andreas (University of Heidelberg)
    Abstract: We characterize optimal incentive contracts in a moral hazard framework extended in two directions. First, after effort provision, the agent is free to leave and pursue some ex-post outside option. Second, the value of this outside option is increasing in effort, and hence endogenous. Optimal contracts may entail properties such as inducing first-best effort and surplus, or non-responsiveness with respect to changes in verifiable parameters. Moreover, while always socially inefficient, separation might occur in equilibrium. Except for the latter, these findings are robust to renegotiation. When the outside option is exogenous instead, the standard results obtain.
    Keywords: moral hazard, limited commitment, ex-post outside option, limited liability
    JEL: D86 D82 K31 M52
    Date: 2010–06
  2. By: Alberto Bisin; John Geanakoplos; Piero Gottardi; Enrico Minelli; Herakles Polemarchakis
    Abstract: Economies with asymmetric information are encompassed by an extension of the model of general competitive equilibrium that does not require an explicit modeling of private information. Sellers have discretion over deliveries on contracts; this is in common with economies with default, incomplete contracts or price rigidities. Competitive equilibria exist and anonymous markets are viable. But, for a generic economy, there exist Pareto improving interventions via linear, anonymous taxes.
    Keywords: asymmetric information, competitive markets, equilibrium
    JEL: D50 D52 D82
    Date: 2010
  3. By: Biais, Bruno; Bossaerts, Peter; Spatt, Chester
    Date: 2010
  4. By: Antonio Nicita; Simone Sepe
    Abstract: Contrary to previous literature, we show that the assignment of authority decision matters in optimal contract design with bilateral specific self-investments. This is the case when we enlarge the set of the states of nature, to explicitly consider the event that a party's market option turns out to be binding ex-post. We show that, under this setting, simple contracts protected by specific performance remedies may generate hold-up and thus parties' incentives to under-invest. However, investment efficiency is enhanced when authority is assigned to the party with ex-post binding market option. Our results suggest a neglected rationale for vertical integration as a remedy against hold-up
    Keywords: incomplete contracts, outside options, mechanism design
    JEL: K12 L22 J41 C70
    Date: 2010–05
  5. By: Quillérou, Emmanuelle; Fraser, Rob, Prof.; Fraser, Iain, Dr
    Abstract: The Environmental Stewardship Scheme provides payments to farmers for the provision of environmental services based on foregone agricultural income. This creates a potential incentive compatibility problem which, combined with an information asymmetry on farm land heterogeneity, could lead to adverse selection of farmers into the Scheme and therefore reduced cost-effectiveness of the Scheme. This reduced cost-effectiveness would be represented by a systematic overpayment of farmers for the land enrolled into the Scheme, compared to the opportunity cost of production. This paper examines the potential adverse selection problem affecting the higher tier of the Environmental Stewardship, the Higher Level Stewardship, using a principal agent framework combined with farm-level data on participation in the HLS. Empirically, it is found that, at the farm level, HLS participation is negatively related to cereal yields, suggesting the existence of adverse selection in the HLS and farmer overcompensation from entering the scheme.
    Keywords: Adverse selection, agri-environment, Environmental Stewardship, principal-agent, contract, Environmental Economics and Policy, D78, D82, H44, Q18, Q58,
    Date: 2010–03–29
  6. By: Roland Hodler; Simon Loertscher; Dominic Rohner
    Abstract: Decision makers lacking crucial specialist know-how often consult with better informed but biased experts. In our model the decision maker’s choice problem is binary and her preferred option depends on the state of the world unknown to her. The expert observes the state and sends a report to the decision maker. His bias is such that he prefers the same decision for all states. Lying about the state leads to a cost that increases in the size of the lie. As a function of the size of the expert’s bias and the decision maker’s prior about the underlying state, three kinds of equilibrium behavior occur. In each case equilibrium consists of separating and pooling segments, and the decision maker takes the expert’s preferred decision for some states for which she would not take this decision had she observed the state herself. The model has a variety of applications and extends to situations in which the decision maker may be naive and take the report by its face value, and to situations with multiple experts and uncertainty about the size of the expert’s bias.
    Keywords: Experts, policy advice, information distortion, costly signalling
    JEL: C72 D72 D82
    Date: 2010–07
  7. By: Ulrich Horst; Santiago Moreno-Bromberg
    Abstract: In this paper the problem of optimal derivative design, profit maximization and risk minimization under adverse selection when multiple agencies compete for the business of a continuum of heterogenous agents is studied. In contrast with the principal-agent models that are extended within, here the presence of ties in the agents' best-response correspondences yields discontinuous payoff functions for the agencies. These discontinuities are dealt with via efficient tie-breaking rules. The main results of this paper are a proof of existence of (mixed-strategies) Nash equilibria in the case of profit-maximizing agencies, and of socially efficient allocations when the firms are risk minimizers. It is also shown that in the particular case of the entropic risk measure, there exists an efficient "fix-mix" tie-breaking rule, in which case firms share the whole market over given proportions.
    Keywords: Adverse selection, Nash equilibria, Pareto optimality, risk transfer, socially efficient allocations, tie-breaking rules
    JEL: C62 C72 D43 D82 G14
    Date: 2010–07
  8. By: Michiel Bijlsma; Jeroen Klomp; Sijmen Duineveld
    Abstract: The financial crisis has put systemic risk firmly on the policy agenda. In such a crisis, an initial shock gets amplified while it propagates to other financial intermediaries, ultimately disrupting the financial sector. We review the literature on such amplification mechanisms which create externalities from risk taking. We distinguish between two classes of mechanisms: contagion within the financial sector and pro-cyclical connection between the financial sector and the real economy. Regulation can diminish systemic risk by reducing these externalities. However, regulation of systemic risk faces several problems. First, systemic risk and its costs are difficult to quantify. Second, banks have strong incentives to evade regulation meant to reduce systemic risk. Third, regulators are prone to forbearance. Finally, the inability of governments to commit not to bail out systemic institutions creates moral hazard and reduces the market’s incentive to price systemic risk. Strengthening market discipline can play an important role in addressing these problems, because it reduces the scope for regulatory forbearance, does not rely on complex information requirements, and is difficult to manipulate.
    Keywords: Financial markets; Contagion; Systemic risk
    JEL: G28
    Date: 2010–07
  9. By: Eső, Péter; Schummer, James
    Abstract: In games with costly signaling, some equilibria are vulnerable to deviations which could be "unambiguously" interpreted as coming from a unique set of Sender-types. This occurs when these types are precisely the ones who gain from deviating for any beliefs the Receiver could form over that set. We show that this idea characterizes a unique equilibrium outcome in two classes of games. First, in monotonic signaling games, only the Riley outcome is immune to this sort of deviation. Our result therefore provides a plausible story behind the selection made by Cho and Kreps' (1987) D1 criterion on this class of games. Second, we examine a version of Crawford and Sobel's (1982) model with costly signaling, where standard refinements have no effect. We show that only a Riley-like separating equilibrium is immune to these deviations.
    JEL: C72 C70
    Date: 2009–11
  10. By: Kaiser, Karolina
    Abstract: This dissertation deals with the topic of bailouts in federations. Institutions and instruments helping to alleviate the incentive problems arising from bailouts are analyzed. In particular, the role of the timing of elections, bailout restrictions and the exploitation of budgetary information from comparable jurisdictions is considered.
    Keywords: Federations; Bailouts; Commitment Problem; Timing of Elections; Budgetary Crisis
    Date: 2010–01–27
  11. By: Sauré, Philip (Swiss National Bank)
    Abstract: An increasing number of oil market experts argue that OPEC members substantially overstate their oil reserves. While the economic implications could be dire, the incentives for overreporting remain unclear. This paper analyzes these incentives, showing that oil exporters may overreport to raise expected future supply, thereby discouraging oil-substituting R&D and improving their own future market conditions. In general, however, overreporting is not costless: it must be backed by observable actions and therefore induces losses through supply distortions. Surprisingly, these distortions offset others that arise when suppliers internalize the buyers’ motives for R&D. In this case, overreporting is rational, credible, and cheap.
    Keywords: Exhaustible Resource; Substitution Technology; Signaling
    JEL: D82 F10 F16
    Date: 2010–01–31

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