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on Contract Theory and Applications |
| By: | Jaynes, Gerald D. (Yale University) |
| Abstract: | Shows equilibrium always exists (Rothschild-Stiglitz-Wilson model) when firms enforce policy exclusivity via strategic (profit-maximizing) communication of client purchases. Strategic communication induces two equilibrium types: partial communication of purchase information or non-communication which exhibits a lemon effect (low-risk purchase no insurance). Nonetheless, Jaynes' configuration (Jaynes; Beaudry & Poitevin) allocating both risk-types a low-coverage pooling contract and high-risk supplementary expensive coverage always characterizes equilibrium including Perfect Bayesian Equilibrium in Hellwig's two-stage framework where inter-firm informational asymmetries impose additional "competitive" features. Adverse selection induces salient features of financial markets: Bertrand-Edgeworth competition, latent contracts, strategic exclusivity-policy cancellation tactics, market institutions for sharing information. |
| JEL: | D82 G22 |
| Date: | 2011–05 |
| URL: | http://d.repec.org/n?u=RePEc:ecl:yaleco:91&r=cta |
| By: | Vives, Xavier (IESE Business School) |
| Abstract: | This paper performs a welfare analysis of economies with private information when public information is endogenously generated and agents can condition on noisy public statistics in the rational expectations tradition. We find that equilibrium is not (restricted) efficient even when feasible allocations share similar properties to the market context (e.g., linear in information). The reason is that the market in general does not internalize the informational externality when public statistics (e.g., prices) convey information. Under strategic substitutability, equilibrium prices will tend to convey too little information when the "informational" role of prices prevails over its index of scarcity" role and too much information in the opposite case. Under strategic complementarity, prices always convey too little information. These results extend to the internal efficiency benchmark (accounting only for the collective welfare of the active players). However, received results-on the relative weights placed by agents on private and public information, when the latter is exogenous-may be overturned. |
| Keywords: | information externality; strategic complementarity and substitutability; asymmetric information; team solution; rational expectations; schedule competition; behavioral traders; |
| Date: | 2011–06–01 |
| URL: | http://d.repec.org/n?u=RePEc:ebg:iesewp:d-0925&r=cta |
| By: | Vives, Xavier (IESE Business School) |
| Abstract: | This paper presents a market with asymmetric information where a privately revealing equilibrium obtains in a competitive framework and where incentives to acquire information are preserved. The equilibrium is efficient, and the paradoxes associated with fully revealing rational expectations equilibria are precluded without resorting to noise traders. The rate at which equilibria in finite replica markets with n traders approach the equilibrium in the continuum economy is 1 n , slower than the rate of convergence to price-taking behavior (1 n ); and the per capita welfare loss is dissipated at the rate 1 n , slower than the rate at which inefficiency due to market power vanishes (1 n2 ). The model admits a einterpretation in which behavioral traders coexist with rational traders, and it allows us to characterize the amount of induced mispricing. |
| Keywords: | adverse selection; information acquisition; double auction; multi-unit auctions; rate convergence; behavioral traders; complementarities; |
| Date: | 2011–05–07 |
| URL: | http://d.repec.org/n?u=RePEc:ebg:iesewp:d-0924&r=cta |
| By: | Maitreesh Ghatak; Alexander Karaivanov |
| Abstract: | We analyze optimal contracts and optimal matching patterns in a simple model of partnership where there is a double-sided moral hazard problem and potential partners differ in their productivity in two tasks. It is possible for one individual to accomplish both tasks (sole production) and there are no agency costs associated with this option but partnerships are a better option if comparative advantages are significant. We show that the presence of moral hazard can reverse the optimal matching pattern relative to the first best, and that even if partnerships are optimal for an exogenously given pair of types, they may not be observed in equilibrium when matching is endogenous, suggesting that empirical studies on agency costs are likely to underestimate their extent by focusing on the intensive margin and ignoring the extensive margin. |
| Keywords: | Endogenous matching, partnerships, contractual structure |
| JEL: | D21 D23 D82 D12 Q15 |
| Date: | 2011–02 |
| URL: | http://d.repec.org/n?u=RePEc:cep:stieop:024&r=cta |
| By: | Rocco Ciciretti (Faculty of Economics, University of Rome "Tor Vergata"); Simone Meraglia (Toulouse School of Economics); Gustavo Piga (Faculty of Economics, University of Rome "Tor Vergata") |
| Abstract: | We study a three-tier hierarchy Political Principal - Competition Authority - Firms in which the Principal chooses the Authority's (i) exante budget, (ii) state-contingent transfer, and (iii) preferences in presence of moral hazard. Collusion between the Authority and firms may arise so as to avoid fines. For high efficiency levels of side-contracting, collusion proofness induces high-powered incentives for the Authority. The Principal trades-off the benefits from allowing the Authority to exert its desidered level of effort with the cost of leaving it an increasing expected rent. This results in the budget being non-monotone in the side-contracting efficiency level. When firms bribe the Principal for a reduced budget, both the budget and the state-contingent transfer are non-increasing in the side-contracting efficiency level. Instances in which the Authority is optimally allocated a zero budget are characterized. Finally we show that the Principal prefers a consumers' surplus maximizing Competition Authority. |
| Keywords: | Three-tier Hierarchy, Moral Hazard, Collusion-Proofness, Endogenous Budget, Law Enforcement |
| JEL: | D72 D73 D86 K21 |
| Date: | 2011–07–14 |
| URL: | http://d.repec.org/n?u=RePEc:rtv:ceisrp:208&r=cta |
| By: | Biran, Omer |
| Abstract: | We consider a second price auction between bidders with independently and identically distributed valuations, where a losing bidder suffers a negative direct externality. Considering ex-ante commitments to form bidding rings we study the question of core stability of the grand coalition, namely: is there a subset of bidders that prefers forming a small bidding ring rather than participating in the grand cartel? We show that in the presence of direct externalities between bidders the grand coalition is not necessarily core stable, as opposed to the zero externality case, where the stability of the grand coalition is a known result. Finally, we study collusion in auctions as a mechanism design problem, insisting on the difficulty to compare ex-ante and interim commitments. In particular, we show that there are situations in which bidders prefer colluding before privately learning their types. |
| Keywords: | Auctions; collusion; externalities; Bayesian games; core; partition function game; mechanism design. |
| JEL: | C71 D44 C72 |
| Date: | 2011–03 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:32164&r=cta |
| By: | Allen, Franklin; Babus, Ana; Carletti, Elena |
| Abstract: | We develop a model in which asset commonality and short-term debt of banks interact to generate excessive systemic risk. Banks swap assets to diversify their individual risk. Two asset structures arise. In a clustered structure, groups of banks hold common asset portfolios and default together. In an unclustered structure, defaults are more dispersed. Portfolio quality of individual banks is opaque but can be inferred by creditors from aggregate signals about bank solvency. When bank debt is short-term, creditors do not roll over in response to adverse signals and all banks are inefficiently liquidated. This information contagion is more likely under clustered asset structures. In contrast, when bank debt is long-term, welfare is the same under both asset structures. |
| Keywords: | interim information; rollover risk.; Short-term debt |
| JEL: | D85 G21 |
| Date: | 2011–07 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:8476&r=cta |
| By: | Vives, Xavier (IESE Business School) |
| Abstract: | The paper analyzes a very stylized model of crises and demonstrates how the degree of strategic complementarity in the actions of investors is a critical determinant of fragility. It is shown how the balance sheet composition of a financial intermediary, parameters of the information structure (precisions of public and private information), and the level of stress indicators in the market impinge on the degree of strategic complementarity. The model distinguishes between solvency and liquidity risk and characterizes them. Both a solvency (leverage) and a liquidity ratio are required to control the probabilities of insolvency and illiquidity. It is found that in a more competitive environment (with higher return on short-term debt) the solvency requirement has to be strengthened, and in an environment where the fire sales penalty is higher and fund managers are more conservative the liquidity requirement has to be strengthened while the solvency one relaxed. Higher disclosure or introducing a derivatives market may backfire, aggravating fragility (in particular when the asset side of a financial intermediary is opaque) and, correspondingly, liquidity requirements should be tightened. The model is applied to interpret the 2007 run on SIV and ABCP conduits. |
| Keywords: | stress; crises; illiquidity risk; insolvency risk; leverage ratio; liquidity ratio; derivatives market; disclosure; |
| Date: | 2011–06–05 |
| URL: | http://d.repec.org/n?u=RePEc:ebg:iesewp:d-0928&r=cta |