nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2011‒11‒01
seven papers chosen by
Simona Fabrizi
Massey University, Albany

  1. Robust Predictions in Games with Incomplete Information By Dirk Bergemann; Stephen Morris
  2. Correlated Equilibrium in Games with Incomplete Information By Dirk Bergemann; Stephen Morris
  3. Moral hazard and lack of commitment in dynamic economies By Alexander K. Karaivanov; Fernando M. Martin
  4. Firms’ moral hazard in sickness absences By René Böheim; Thomas Leoni
  5. Reinsuring the Poor: Group Microinsurance Design and Costly State Verification By Daniel J. Clarke
  6. Dark Pool Trading Strategies By Sabrina Buti; Barbara Rindi; Ingrid M. Werner
  7. Costly Contracts and Consumer Credit By Igor Livshits; James MacGee; Michèle Tertilt

  1. By: Dirk Bergemann; Stephen Morris
    Date: 2011–10–20
  2. By: Dirk Bergemann; Stephen Morris
    Date: 2011–10–20
  3. By: Alexander K. Karaivanov; Fernando M. Martin
    Abstract: We revisit the role of limited commitment in a dynamic risk-sharing setting with private information. We show that a Markov-perfect equilibrium, in which agent and insurer cannot commit beyond the current period, and an infinitely-long contract to which only the insurer can commit, implement identical consumption, effort and welfare outcomes. Unlike contracts with full commitment by the insurer, Markov-perfect contracts feature non-trivial and determinate asset dynamics. Numerically, we show that Markov-perfect contracts provide sizable insurance, especially at low asset levels, and are able to explain a significant part of wealth inequality beyond what can be explained by self-insurance. The welfare gains from resolving the commitment friction are larger than those from resolving the moral hazard problem at low asset levels, while the opposite holds for high asset levels.
    Keywords: Moral hazard ; Risk
    Date: 2011
  4. By: René Böheim (Department of Economics, Johannes Kepler University Linz, Austria); Thomas Leoni (Österreichisches Institut für Wirtschaftsforschung (WIFO) (Austrian Institute of Economic Research))
    Abstract: Sick workers in many countries receive sick pay during their illness- related absences from the workplace. In several countries, the social security system insures firms against their workers’ sickness absences. However, this insurance may create moral hazard problems for firms, leading to the inefficient monitoring of absences or to an underinvestment in their prevention. In the present paper, we investigate firms’ moral hazard problems in sickness absences by analyzing a legislative change that took place in Austria in 2000. In September 2000, an insurance fund that refunded firms for the costs of their blue-collar workers’ sickness absences was abolished (firms did not receive a similar refund for their white-collar workers’ sickness absences). Before that time, small firms were fully refunded for the wage costs of blue- collar workers’ sickness absences. Large firms, by contrast, were refunded only 70% of the wages paid to sick blue-collar workers. Using a difference-in-differences-in-differences approach, we estimate the causal impact of refunding firms for their workers’ sickness absences. Our results indicate that the incidences of blue-collar workers’ sicknesses dropped by approximately 8% and sickness absences were almost 11% shorter following the removal of the refund. Several robustness checks confirm these results.
    Keywords: absenteeism, moral hazard, sickness insurance
    JEL: J22 I38
    Date: 2011–09
  5. By: Daniel J. Clarke
    Abstract: This paper analyses collusion-proof multilateral insurance contracts between a risk neutral insurer and multiple risk averse agents in an environment of asymmetric costly state verification. Optimal contracts involve the group of agents pooling uncertainty and the insurer acting as reinsurer to the group, auditing and paying a claim only when the group or a sub-group has incurred a large enough aggregate loss. We interpret our models as providing support for insurance contracts between insurance providers, such as microinsurers or governments, and groups of individuals who have access to cheap information about each other, such as extended families or members of close-knit communities. Such formal contracts complement, and could even crowd in, cheap nonmarket insurance arrangements.
    Keywords: Microinsurance, Group insurance, Costly state verification, Mechanism design
    JEL: D14 D82 G22 O16
    Date: 2011
  6. By: Sabrina Buti; Barbara Rindi; Ingrid M. Werner
    Abstract: We model a financial market where traders have access both to a fully transparent limit order book (LOB) and to an opaque Dark Pool (DP). When a DP is introduced to a LOB market,orders migrate to the DP from the LOB, but overall trading volume increases. Moreover, inside quoted depth in the LOB decreases, but quoted spreads tend to narrow in deep books and widen in shallow ones. DP market share is higher when LOB depth is high, when LOB spread is narrow, when the tick size is large and when traders seek protection from price impact. When depth decreases on one side of the LOB, liquidity is drained from the DP. When Flash orders provide select traders with information about the state of the DP, more orders migrate from the LOB to the DP but overall market quality improves.
    Date: 2011
  7. By: Igor Livshits (University of Western Ontario); James MacGee (University of Western Ontario); Michèle Tertilt (University of Mannheim, Stanford University, NBER and CEPR)
    Abstract: Financial innovations are a common explanation of the rise in consumer credit and bankruptcies. To evaluate this story, we develop a simple model that incorporates two key frictions: asymmetric information about borrowers’ risk of default and a fixed cost to create each contract offered by lenders. Innovations which reduce the fixed cost or ameliorate asymmetric information have large extensive margin effects via the entry of new lending contracts targeted at riskier borrowers. This results in more defaults and borrowing, as well as increased dispersion of interest rates. Using the Survey of Consumer Finance and interest rate data collected by the Board of Governors, we find evidence supporting these predictions, as the dispersion of credit card interest rates nearly tripled, and the share of credit card debt of lower income households nearly doubled.
    Keywords: consumer credit; endogenous financial contracts; bankruptcy
    JEL: E21 E49 G18 K35
    Date: 2011

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