nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2011‒08‒15
eight papers chosen by
Simona Fabrizi
Massey University, Albany

  1. Entry deterrence in banking: the role of cost asymmetry and adverse selection By Mallick, Indrajit
  2. Trilateral Contract and the Hold-up Problem By Regine Oexl
  3. Equilibrium model with default and insider's dynamic information By Luciano Campi; Umut Cetin; Albina Danilova
  4. Moral Hazard, Targeting and Contract Duration in Agri-Environmental Policy By Fraser, Rob W.
  5. Core and Equilibria under ambiguity By Luciano De Castro; Marialaura Pesce; Nicolas Yannelis
  6. Preparing for Basel IV (whilst commending Basel III) : why liquidity risks still present a challenge to regulators in prudential supervision ( Part II) By Ojo, Marianne
  7. Investment, Consumption, and Hedging under Incomplete Markets By Jianjun Miao; Neng Wang
  8. Intention-Based Reciprocity and the Hidden Costs of Control By Ferdinand von Siemens

  1. By: Mallick, Indrajit
    Abstract: Abstract In this paper, we review and explore the strategic mechanisms that deter entry in banking. The literature relies on externality between banks to generate entry deterrence. Typically, the externality generated is caused by differential adverse selection faced by incumbents and entrants. In this paper it is shown that adverse selection problem between a bank and its borrowers is neither a necessary nor a sufficient condition for entry deterrence. We show that cost asymmetry between different types of incumbents and private information about costs can generate conditional entry deterrence. This source of externality can cause entry deterrence just as other types of externalities created by differential adverse selection. Forward contracts can act as signaling device for incumbent costs. Incorporating adverse selection problem in the credit market in fact relaxes entry conditions: entry can take place even if the incumbent is of strong type and can signal credibly.
    Keywords: Key Words: Entry Deterrence; Cost Asymmetry; Adverse Selection; Signaling
    JEL: C70 G21
    Date: 2011–07–08
  2. By: Regine Oexl (Università di Padova)
    Abstract: We present a novel solution for the hold up problem, when more than two parties are involved. The case we consider is a company selling identical products to two buyers that have a common interest in inducing the seller to make a quality enhancing investment. We show that a trilateral contract may provide the correct incentives to restore optimal efficiency. The contract induces a coalition proof Nash equilibrium and holds under complete as well as incomplete information. The extension to more than two buyers is straightforward.
    Keywords: Multilateral Contract, Trilateral Contract, Hold-up Problem.
    JEL: L14 D82
    Date: 2011–01
  3. By: Luciano Campi (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - CNRS : UMR7534 - Université Paris Dauphine - Paris IX, FiME - Laboratoire de Finance des Marchés d'Energies - Université Paris Dauphine - Paris IX); Umut Cetin (Department of Statistics, LSE - London School of Economics); Albina Danilova (Department of Mathematics, LSE - London School of Economics)
    Abstract: We consider an equilibrium model á la Kyle-Back for a defaultable claim issued by a given firm. In such a market the insider observes \emph{continuously in time} the value of firm, which is unobservable by the market maker. Using the construction of a dynamic Bessel bridge of dimension $3$ in Campi, \c Cetin and Danilova (2010), we provide the equilibrium price and the optimal insider's strategy. As in Campi and \c Cetin (2007), the information released by the insider while trading optimally makes the default time predictable in market's view at the equilibrium. We conclude the paper by comparing the insider's expected profits in the static and dynamic private information case. We also compute explicitly the value of insider's information in the special cases of a defaultable stock and a bond.
    Date: 2011–08–03
  4. By: Fraser, Rob W.
    Abstract: This paper extends the multi-period agri-environmental contract model of Fraser (2004) so that it contains a more realistic specification of the inter-temporal penalties for non-compliance, and therefore of the inter-temporal moral hazard problem in agri-environmental policy design. On this basis it is shown that a farmer will have an unambiguous preference for cheating early over cheating late in the contract period based on differences in the expected cost of compliance. It is then shown how the principal can make use of this unambiguous preference to target monitoring resources intertemporally, and in so doing, to encourage full contract duration compliance.
    Keywords: Moral Hazard, Contract Duration, Agri-Environmental Policy, Targeting, Agribusiness, Environmental Economics and Policy, Q15, Q18, Q58,
    Date: 2011–04
  5. By: Luciano De Castro; Marialaura Pesce; Nicolas Yannelis
    Abstract: This paper introduces new core and Walrasian equilibrium notions for an asymmetric information economy with non-expected utility preferences. We prove existence and incentive compatibility results for the new notions we introduce.
    Date: 2011–03–07
  6. By: Ojo, Marianne
    Abstract: Whilst the predecessor (Part I) to this paper addresses criticisms and challenges which have arisen in response to recent Basel Committee's initiatives aimed at addressing capital and liquidity standards, the present paper highlights further measures which are being introduced by the Basel Committee to address such criticisms and challenges. As well as presenting and drawing attention to proposals which could serve as means of addressing challenges presented by liquidity risks, Part I of the paper concludes with the result that market based regulation is an essential and vital tool in the Basel Committee's efforts to address some of the challenges presented by liquidity risks. The present paper highlights the Basel Committee's acknowledgement of this conclusion. Furthermore, it draws attention to other areas which are considered to constitute fertile substrates for purposes of future research. This paper will also illustrate why the potential of banking regulations and disclosure requirements to impact risk taking levels is not only dependent on certain factors such as the dissemination of information to appropriate recipients, appropriate volume of disseminated information, when to disseminate such information, but also on other factors such as ownership structures and effective corporate governance measures aimed fostering monitoring, supervision and accountability. In arguing that additional leverage ratios which have recently been proposed by the Basel Committee will play a key role in facilitating the diversification of banks‘ liquid assets – via the new liquidity standards (Liquidity Coverage Ratio and the Net Stable Funding Ratio), contribution is also made to the current discussion on the resilience of the banking sector – albeit from the perspective of the stabilisation of the entire system.
    Keywords: liquidity risks; systemic risks; capital; standards; Basel III; moral hazard; disclosure; information; Liquidity Coverage Ratio (LCR); Net Stable Funding Ratio (NSFR); accountability; corporate governance
    JEL: K2 E32 G3 D8
    Date: 2010–12–30
  7. By: Jianjun Miao; Neng Wang
    Abstract: Entrepreneurs often face undiversifiable idiosyncratic risks from their business investments. We extend the standard real options approach to an incomplete markets environment and analyze their joint decisions of business investments, consumption/savings, and portfolio selection. For a lump-sum investment payoff and an agent with a su¡Àciently strong precautionary savings motive, an increase in volatility can accelerate investment, contrary to the standard real options analysis. When the agent can trade the market portfolio to partially hedge against investment risk, the systematic volatility is compensated via the standard CAPM argument, and the idiosyncratic volatility generates a private equity premium. Finally, when the investment payoff is a series of flows, the agent's idiosyncratic risk exposure alters both the implied option value and the implied project value, causing a reversal of the results in the lump-sum payoff case.
    Keywords: real options, idiosyncratic risk, hedging, risk aversion, precautionary savings, incomplete markets
    JEL: G11 G31 E2
    Date: 2011
  8. By: Ferdinand von Siemens (University of Amsterdam)
    Abstract: Empirical research suggests that - rather than improving incentives - exerting control can reduce workers' performance by eroding motivation. The present paper shows that intention-based reciprocity can cause such motivational crowding-out if individuals differ in their propensity for reciprocity and preferences are private information. Not being controlled might then be considered to be kind, because not everybody reciprocates not being controlled with high effort. This argument stands in contrast to existing theoretical wisdom on motivational crowding-out that is primarily based on signaling models.
    Keywords: extrinsic and intrinsic motivation; crowding-out; intention-based reciprocity
    JEL: A13 C70 D63 D82 L20
    Date: 2011–08–09

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