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on Contract Theory and Applications |
| By: | Chemla, Gilles; Hennessy, Christopher |
| Abstract: | We examine screening incentives, welfare and the case for mandatory skin-in-the-game. Ex ante banks can screen, using interim private information to choose retentions and structuring. Ex post speculators trade with rational hedging investors. Absent regulation, there is a separating equilibrium with voluntary retentions. If funding value is high, banks may instead originate-to-distribute (OTD), selling the entire asset in opaque form, deterring informed speculation and destroying screening incentives. Under weaker conditions, banks instead sell the asset in transparent form, using tranching to increase hedging demand, informed speculation and price informativeness. With sufficient informed speculation, transparent OTD actually creates stronger screening incentives than voluntary retentions. In all unregulated market equilibria, interim adverse selection reduces screening incentives, so mandated retentions potentially increase welfare. To induce screening via pooling, banks should be required to retain a uniform junior tranche size which decreases in informational efficiency. However, uniform retention mandates may not be optimal. To improve risk-sharing, screening can instead be induced via separating contracts by compelling banks to choose from a menu of junior tranche retention sizes. In either case, efficiency of risk-sharing is maximized by splitting marketed claims into safe senior and risky mezzanine tranches. Finally, the separating (pooling) regulatory regime generally leads to higher welfare if efficient risk-sharing (bank investment scale) is the dominant consideration, and is always optimal in informationally inefficient markets. |
| Keywords: | adverse selection; originate to distribute; screening incentives; securitization; skin in the game; speculator; uninformed investors |
| JEL: | D82 G21 G32 G38 L51 |
| Date: | 2011–05 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:8403&r=cta |
| By: | Mikhail Golosov (Dept. of Economics, Yale University); Vasiliki Skreta (NYU, Stern School of Business); Aleh Tsyvinski (Dept. of Economics, Yale University); Andrea Wilson (NYU) |
| Abstract: | This paper studies strategic information transmission in a dynamic environment where, each period, a privately informed expert sends a message and a decision maker takes an action. Our main result is that, in contrast to a static environment, full information revelation is possible. The gradual revelation of information and the eventual full revelation is supported by the dynamic rewards and punishments. The construction of a fully revealing equilibrium relies on two key features. The first feature is that the expert is incentivized, via appropriate actions, to join separable groups in which she initially pools with far-away types, then later reveals her type. The second feature is the use of trigger strategies. The decision maker is incentivized by the reward of further information revelation if he chooses the separation-inducing actions, and the threat of a stop in information release if he does not. Our equilibrium is non-monotonic. With monotonic partition equilibria, full revelation is impossible. |
| Keywords: | Asymmetric information, Cheap talk, Dynamic strategic communication, Full information revelation |
| JEL: | D82 D83 |
| Date: | 2011–05 |
| URL: | http://d.repec.org/n?u=RePEc:cwl:cwldpp:1802&r=cta |
| By: | Iossa, Elisabetta; Martimort, David |
| Abstract: | We study the agency costs of delegated public service provision, focusing on the link between organizational forms and uncertainty at project implementation. We consider a dynamic multitask moral hazard environment where the mapping between effort and performance is ex ante uncertain but new information may come along during operations. Our analysis points out at the efficiency gains that bundling planning and implementation - as under Public Private Partnerships - can bring in terms of better project design and lower operational costs. Bundling also results in increasingly better performance as uncertainty is reduced by growing experience in the sector. Bundling should instead be viewed with caution when the private sector seeks to radically innovate on public service provision or to introduce new services but lacks the knowledge and expertise to anticipate the impact of the innovative design/procedure/technology on the cost of operations. The compounding of asymmetric information ex post plus moral hazard and renegotiation may generate diseconomies of scope in agency costs which, for high operational risk, can make unbundling optimal. In this context, the use of private finance can help re-establishing the benefit of bundling only if lenders have sufficient expertise to help assessing project risks. |
| Date: | 2011–05 |
| URL: | http://d.repec.org/n?u=RePEc:cpm:docweb:1104&r=cta |
| By: | Emmanuelle Auriol (TSE (ARQADE and IDEI), Université de Toulouse I (France)); Pierre M. Picard (CREA, University of Luxembourg (Luxembourg), and CORE, Université catholique de Louvain (Belgium).) |
| Abstract: | In this paper, we discuss the choice for build-operate-and-transfer (BOT) concessions when governments and firm managers do not share the same information regarding the operation characteristics of a facility. We show that larger shadow costs of public funds and larger information asymmetries entice governments to choose BOT concessions. This result stems from a trade-off between the government's shadow costs of financing the construction and the operation of the facility and the excessive usage price that the consumer may face during the concession period. The incentives to choose BOT concessions increase as a function of ex-ante informational asymmetries between governments and potential BOT concession holders and with the possibility of transferring the concession cost characteristics to public firms at the termination of the concession. |
| Keywords: | Public-private-partnership, privatization, adverse selection, regulation, natural monopoly, infrastructure, facilities. |
| JEL: | L43 L51 D82 L33 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:luc:wpaper:11-04&r=cta |
| By: | Michal Kowalik |
| Abstract: | The paper derives optimal capital requirements, when the bank’s quality is private information. The supervisor can inspect the bank and punish the undercapitalized one with recapitalization and downsizing. The cost of bank’s capital and its ability to sell its assets are crucial for the bank’s incentive to reveal its quality truthfully. The paper provides following policy implications. First, sensitivity of capital requirements to the bank’s quality should be low in good times and high in bad times. Second, a leverage ratio should be accompanied by a requirement that the bank selling its assets retains part of them. Third, using results from supervisory inspection on the secondary market for the bank’s assets increases the bank’s incentive to misreport its quality. Fourth, implementation of the sensitive capital requirements cannot rely solely on information revealed on the market for the bank’s assets. |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:fip:fedkrw:rwp11-02&r=cta |
| By: | Chen, Ning (Nanyang Technological University); Ghosh, Arpita (Yahoo! Research); Lambert, Nicolas S. (Stanford University) |
| Abstract: | Prosper, the largest online social lending marketplace with over a million members and $207 million in funded loans, uses an auction amongst lenders to finance each loan. In each auction, the borrower specifies D, the amount he wants to borrow, and a maximum acceptable interest rate R. Lenders specify the amounts a[subscript i] they want to lend, and bid on the interest rate, b[subscript i], they're willing to receive. Given that a basic premise of social lending is cheap loans for borrowers, how does the Prosper auction do in terms of the borrower's payment, when lenders are strategic agents with private true interest rates? We first provide an analysis of the complete information game and fully characterize the Nash equilibria of the Prosper mechanism. Next, we show that while the borrower's payment in the VCG mechanism is always within a factor of O(logD) of the payment in any equilibrium of Prosper, even the cheapest Nash equilibrium of the Prosper mechanism can be as large as a factor D of the VCG payment; both factors are tight. Thus, while the Prosper mechanism is a simple uniform price mechanism, it can lead to much larger payments for the borrower than the VCG mechanism. Finally, we consider an incomplete information setting and derive the Bayesian optimal auction for the borrower, which, perhaps surprisingly, may prefer to assign the loan to lenders with high interest-rates over lenders with lower interest rates, when lenders' budgets and interest-rates are correlated. |
| Date: | 2011–05 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:stabus:2078&r=cta |
| By: | Baake, Pio; von Schlippenbach, Vanessa |
| Abstract: | This paper examines how delivery tariffs and private quality standards are determined in vertical relations that are subject to asymmetric information. We consider an infinitely repeated game where an upstream firm sells a product to a downstream firm. In each period, the firms negotiate a delivery contract comprising the quality of the good as well as a nonlinear tariff. Assuming asymmetric information about the actual quality of the product and focusing on incentive compatible contracts, we show that from the firms' perspective delivery contracts lead to more efficient contracts and thus higher overall profits the lower the firms' outside options, i.e. the higher their mutual dependency. Buyer power driven by a reduced outside option of the upstream firm enhances the efficiency of vertical relations, while buyer power due to an improved outside option of the downstream firm implies less effcient outcomes. -- |
| Keywords: | Quality Uncertainty,Private Standards,Vertical Relations,Buyer Power |
| JEL: | D82 L14 L15 |
| Date: | 2011 |
| URL: | http://d.repec.org/n?u=RePEc:zbw:dicedp:18&r=cta |
| By: | Daron Acemoglu; Matthew O. Jackson |
| Abstract: | We study the evolution of the social norm of "cooperation" in a dynamic environment. Each agent lives for two periods and interacts with agents from the previous and next generations via a coordination game. "History" matters because agents only receive noisy information about the play of the previous generation and their interpretation of these signals is shaped by history. We characterize the conditions under which history completely drives equilibrium play, leading to a social norm of high or low cooperation. The impact of history is potentially countered by "prominent" agents, whose actions are more visible (in our baseline model, observed by all future agents), and who can leverage their greater visibility to influence expectations of other agents and overturn social norms of low cooperation. We also show that in equilibria not completely driven by history, there is a pattern of "reversion" whereby play starting with high (low) cooperation reverts toward lower (higher) cooperation. We study the evolution of the social norm of "cooperation" in a dynamic environment. Each agent lives for two periods and interacts with agents from the previous and next generations via a coordination game. "History" matters because agents only receive noisy information about the play of the previous generation and their interpretation of these signals is shaped by history. We characterize the conditions under which history completely drives equilibrium play, leading to a social norm of high or low cooperation. The impact of history is potentially countered by "prominent" agents, whose actions are more visible (in our baseline model, observed by all future agents), and who can leverage their greater visibility to influence expectations of other agents and overturn social norms of low cooperation. We also show that in equilibria not completely driven by history, there is a pattern of "reversion" whereby play starting with high (low) cooperation reverts toward lower (higher) cooperation. |
| JEL: | C72 C73 D7 P16 Z1 |
| Date: | 2011–05 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:17066&r=cta |
| By: | Gennaioli, Nicola |
| Abstract: | I build a model where potentially biased judges verify complex states by interpreting an imperfect signal whose noise captures factual ambiguities. In a sales and a financial transaction I show that judicial biases amplify and distort factual ambiguities, creating enforcement risk. To insure against such risk, parties write simple non-contingent contracts that optimally protect the party that is most vulnerable to judicial error. These results shed light on the empirical association between law and finance and rationalize salient features of real world enforcement regimes. |
| Keywords: | imperfect judicial enforcement; optimal contracts |
| JEL: | K00 |
| Date: | 2011–05 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:8405&r=cta |