nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2010‒08‒21
nine papers chosen by
Simona Fabrizi
Massey University, Albany

  1. Mediation and Peace By Johannes Horner; Massimo Morelli; Francesco Squintani
  2. Should Auctions be Transparent? By Dirk Bergemann; Johannes Horner
  3. Growth Forecasts, Belief Manipulation and Capital Markets By Lundtofte, Frederik; Leoni, Patrick
  4. Low quality as a signal of high quality By Clements, Matthew T.
  5. Hiding an Inconvenient Truth: Lies and Vagueness (Revision of DP 2008-107) By Serra Garcia, M.; Damme, E.E.C. van; Potters, J.J.M.
  6. The Dynamics in Requested and Granted Loan Terms when Bank and Borrower Interact Repeatedly By Kirschenmann, K.
  7. Capital Requirements and Credit Rationing By Itai Agur
  8. The Impact of Public Guarantees on Bank Risk Taking: Evidence from a Natural Experiment By Gropp, R.; Grundl, C.; Guttler, A.
  9. The Fixed Price Offer Mechanism in Trade Me Online Auctions By Seamus Hogan; Hamish Kidd; Laura Meriluoto; Andrew Smith

  1. By: Johannes Horner (Cowles Foundation, Yale University); Massimo Morelli (Columbia University & European University Institute); Francesco Squintani (Essex University)
    Abstract: This paper brings mechanism design to the study of conflict resolution in international relations. We determine when and how unmediated communication and mediation reduce the ex ante probability of conflict, in a simple game where conflict is due to asymmetric information. Unmediated communication helps reducing the chance of conflict as it allows conflicting parties to reveal their types and establish type-dependent transfers to avoid conflict. Mediation improves upon unmediated communication when the intensity of conflict is high, or when asymmetric information is large. The mediator improves upon unmediated communication by not precisely reporting information to conflicting parties, and precisely, by not revealing to a player with probability one that the opponent is weak. Surprisingly, in our set up, arbitrators who can enforce settlements are no more effective in reducing the probability of conflict than mediators who can only make non-binding recommendations.
    Keywords: Mediation, War and peace, Imperfect information, Communication games, Optimal mechanism
    JEL: C7
    Date: 2010–08
  2. By: Dirk Bergemann (Cowles Foundation, Yale University); Johannes Horner (Cowles Foundation, Yale University)
    Abstract: We investigate the role of market transparency in repeated first-price auctions. We consider a setting with private and independent values across bidders. The values are assumed to be perfectly persistent over time. We analyze the first-price auction under three distinct disclosure regimes regarding the bid and award history. Of particular interest is the minimal disclosure regime, in which each bidder only learns privately whether he won or lost the auction at the end of each round. In equilibrium, the winner of the initial auction lowers his bids over time, while losers keep their bids constant, in anticipation of the winner’s lower future bids. This equilibrium is efficient, and all information is eventually revealed. Importantly, this disclosure regime does not give rise to pooling equilibria. We contrast the minimal disclosure setting with the case in which all bids are public, and the case in which only the winner’s bids are public. In these settings, an inefficient pooling equilibrium with low revenues always exists with a sufficiently large number of bidders.
    Keywords: First price auction, Repeated auction, Private bids, Information revelation
    JEL: D44 D82 D83
    Date: 2010–08
  3. By: Lundtofte, Frederik (Department of Economics, Lund University); Leoni, Patrick (EUROMED Management)
    Abstract: We analyze how a benevolent government agency would optimally release information about the growth rate of the stochastic dividend process of the financial market. We investigate the effects of the agency's signal on the agents' optimal strategies and equilibrium asset prices. In the case where all investors are rational Bayesian updaters, we show that the agency's optimal choice is to release a manipulative signal (lie) with probability one. However, if there are some nonupdating (inattentive) agents, we find cases where it is optimal for the government agency to send a revealing signal with probability one.
    Keywords: Social welfare; information; forecasting; asset pricing; inattention
    JEL: D80 G11 G12
    Date: 2010–07–31
  4. By: Clements, Matthew T.
    Abstract: If a product has two dimensions of quality, one observable and one not, a firm can use observable quality as a signal of unobservable quality. The correlation between consumers' valuation of high quality in each dimension is a key determinant of the feasibility of such signaling. A firm may use price alone as a signal, or price and quality together. Both signals tend to be used when the market is very uninformed, whereas price signaling alone tends to be used when the market is moderately informed. If high observable quality is inexpensive to provide, then it cannot signal high unobservable quality, and low observable quality is always an indication that unobservable quality is high. --
    Keywords: Signaling,quality
    JEL: D82 L15
    Date: 2010
  5. By: Serra Garcia, M.; Damme, E.E.C. van; Potters, J.J.M. (Tilburg University, Center for Economic Research)
    Abstract: When truth conflicts with efficiency, can verbal communication destroy efficiency? Or are lies or vagueness used to hide inconvenient truths? We consider a sequential 2-player public good game in which the leader has private information about the value of the public good. This value can be low, high, or intermediate, with the latter case giving rise to a prisoners’ dilemma. Without verbal communication, efficiency is achieved, with contributions for high or intermediate values. When verbal com- munication is added, the leader has an incentive to hide the precise truth when the value is intermediate. We show experimentally that, when communication about the value must be precise, the leader frequently lies, preserving efficiency by exaggerating. When communication can be vague, the leader turns to vague messages when the value is intermediate, but not when it is high. Thus, she implicitly reveals all values. Inter- estingly, efficiency is still preserved, since the follower ignores messages altogether and does not seem to realize that vague messages hide inconvenient truths.
    Keywords: Communication;Efficiency;Lying;Public Goods.
    JEL: C72 C92 D83 H41
    Date: 2010
  6. By: Kirschenmann, K. (Tilburg University, Center for Economic Research)
    Abstract: This paper studies how credit constraints develop over bank relationships. I analyze a unique dataset of matched loan application and loan contract information and measure credit constraints as the ratio of requested to granted loan amounts. I find that the most important determinants of receiving smaller than requested loan amounts are firm age and size at the time of the first interaction between borrower and bank. Over loan sequences, credit constraints decease most pronouncedly in the beginning of relationships and for the initially young and small firms. Moreover, the structure of the dataset allows me to disentangle the demand and supply effects behind these observed credit constraints. I find that the gap between requested and granted loan amounts decreases because both sides converge. If previous credit constraints were large, requested amounts increase more moderately, while granted amounts increase more strongly than in the case of small previous constraints. The findings are a sign of the use of dynamic incentives at the bank side to overcome information problems when contracting repeatedly with opaque borrowers. The results further suggest that, particularly in the beginning of a bank relationship, borrowers learn from their previous experience with credit constraints and adjust their demand accordingly.
    Keywords: Credit constraints;relationship lending;small business lending;asymmetric information;learning
    JEL: D82 G20 G21 G30
    Date: 2010
  7. By: Itai Agur
    Abstract: This paper analyzes the trade-off between financial stability and credit rationing that arises when increasing capital requirements. It extends the Stiglitz-Weiss model of credit rationing to allow for bank default. Bank capital structure then matters for lending incentives. With default and rationing endogenous, optimal capital requirements can be analyzed. Introducing bank financiers, the paper also shows that uninsured funding raises the sensitivity of rationing to capital requirements. In a world with much wholesale finance, capital requirements have a stronger impact on the real economy. But wholesale finance also amplifies capital requirements’ effect on default rates.
    Keywords: Rationing; Capital requirements; Regulation; Wholesale finance; Deposit Insurance
    JEL: G21 G28
    Date: 2010–08
  8. By: Gropp, R.; Grundl, C.; Guttler, A. (Tilburg University, Center for Economic Research)
    Abstract: In 2001, government guarantees for savings banks in Germany were removed following a law suit. We use this natural experiment to examine the effect of government guarantees on bank risk taking, using a large data set of matched bank/borrower information. The results suggest that banks whose government guarantee was removed reduced credit risk by cutting off the riskiest borrowers from credit. At the same time, the banks also increased interest rates on their remaining borrowers. The effects are economically large: the Z-Score of average borrowers increased by 7% and the average loan size declined by 13%. Remaining borrowers paid 57 basis points higher interest rates, despite their higher quality. Using a difference-in-differences approach we show that the effect is larger for banks that ex ante benefitted more from the guarantee. We show that both the credit quality of new customers improved (screening) and that the loans of existing riskier borrowers were less likely to be renewed (monitoring), after the removal of public guarantees. Public guarantees seem to be associated with substantial moral hazard effects.
    Keywords: banking;public guarantees;credit risk;moral hazard
    JEL: G21 G28 G32
    Date: 2010
  9. By: Seamus Hogan (University of Canterbury); Hamish Kidd; Laura Meriluoto (University of Canterbury); Andrew Smith
    Abstract: The Fixed Price Offer (FPO) mechanism in Trade Me auctions allows sellers to make a take-it-or-leave-it offer at the conclusion of an unsuccessful auction. We investigate the effects of the FPO option on strategies and outcomes in independent-value auctions. The FPO option induces some bidders with a value above the seller’s reserve to wait for an FPO instead of bidding. Overall, the FPO option increases the probability of sale but reduces expected seller revenue compared to a standard auction. The impact of the FPO option is reduced when the number of bidders increases.
    Keywords: fixed price offer; private value auction; on-line auction; optimal reserve price; second chance offer
    JEL: D44
    Date: 2010–08–13

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