nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2013‒10‒02
thirteen papers chosen by
Simona Fabrizi
Massey University, Albany

  1. Debt Rescheduling with Multiple Lenders: Relying on the Information of Others By Claude Fluet; Paolo G. Garella
  2. Information Provision in Procurement Auctions By Daniel García; Joaquím Coleff
  3. Asymmetric Information and Imperfect Competition in the Loan Market By Crawfordy, Gregory S; Pavaniniz, Nicola; Schivardi, Fabiano
  4. Implementing the "Wisdom of the Crowd" By Kremer, Ilan; Mansour, Yishay; Perry, Motty
  5. Financing Experimentation By Macchiavello, Rocco
  6. Biases and Implicit Knowledge By Cunningham, Thomas
  7. Role of the Credit Risk Database in SME Financing (Japanese) By MAEHARA Yasuhiro
  8. Incentives and Information as Driving Forces of Default Effects By Altmann, Steffen; Falk, Armin; Grunewald, Andreas
  9. Reviewing the Leverage Cycle By Ana Fostel; John Geanakoplos
  10. Cryptography and the economics of supervisory information: balancing transparency and confidentiality By Mark Flood; Jonathan Katz; Stephen J Ong; Adam Smith
  11. Incentivizing Calculated Risk-Taking: Evidence from an Experiment with Commercial Bank Loan Officers By Shawn Cole; Martin Kanz; Leora Klapper
  12. Banking crises, sudden stops, and the effectiveness of short-term lending By Chang, Chia-Ying
  13. Counter-Intelligence in a Command Economy By Harrison, Mark; Zaksauskienė, Inga

  1. By: Claude Fluet; Paolo G. Garella
    Abstract: Can debt rescheduling decisions differ in multiple lenders’ versus a single lender loan? Do multiple lenders efficiently react to information? We show that the precision of information plays an essential role. Foreclosing by one lender is disruptive so that a lender can rationally wait for the decision of other lenders, rescheduling her loan, if she expects that other lenders receive more precise information. We develop a Bayesian game where signals of different precision are randomly distributed to lenders. Both, premature liquidation and excessive rescheduling are possible in equilibrium, according to the pattern of information. However this is a second-best outcome, given that private information cannot be optimally shared.
    Keywords: Overlending, debt contracts, insolvency, illiquidity, liquidation, relationship lending, multiple lenders, Bayesian games
    JEL: G32 G33 D82 D86
    Date: 2013
  2. By: Daniel García; Joaquím Coleff
    Abstract: We analyze the optimal provision of information in a procurement auction with horizontally dierentiated goods. The buyer has private information about her preferred location on the product space and has access to a costless communication device. A seller who pays the entry cost may submit a bid comprising a location and a minimum price. We characterize the optimal information structure and show that the buyer prefers to attract only two bids. Further, additional sellers are inecient since they reduce total and consumer surplus, gross of entry costs. We show that the buyer will not nd it optimal to send public information to all sellers. On the other hand, she may prot from setting a minimum price and that a severe hold-up problem arises if she lacks commitment to set up the rules of the auction ex-ante.
    JEL: D44 D82 H57
    Date: 2013–09
  3. By: Crawfordy, Gregory S (University of Zurich, CEPR and CAGE); Pavaniniz, Nicola (zUniversity of Zurich); Schivardi, Fabiano (xLUISS, EIEF and CEPR)
    Abstract: We measure the consequences of asymmetric information in the Italian market for small business lines of credit. Exploiting detailed, proprietary data on a random sample of Italian firms, the population of medium and large Italian banks, individual lines of credit between them, and subsequent individual defaults, we estimate models of demand for credit, loan pricing, loan use, and firm default based on the seminal work of Stiglitz and Weiss (1981) to measure the extent and consequences of asymmetric information in this market. While our data include a measure of observable credit risk comparable to that available to a bank during the application process, we allow firms to have private information about the underlying riskiness of their project. This riskiness influences banks’ pricing of loans as higher interest rates attract a riskier pool of borrowers, increasing aggregate default probabilities. Data on default, loan size, demand, and pricing separately identify the distribution of private riskiness from heterogeneous firm disutility from paying interest. Preliminary results suggest evidence of asymmetric information, separately identifying adverse selection and moral hazard. We use our results to quantify the impact of asymmetric information on pricing and welfare, and the role imperfect competition plays in mediating these effects.
    Keywords: Italian, asymmetric information
    Date: 2013
  4. By: Kremer, Ilan (Department of Economics, University of Warwick); Mansour, Yishay (Tel Aviv University); Perry, Motty (Department of Economics, University of Warwick)
    Abstract: We study a novel mechanism design model in which agents each arrive sequentially and choose one action from a set of actions with unknown rewards. The information revealed by the principal affects the incentives of the agents to explore and generate new information. We characterize the optimal disclosure policy of a planner whose goal is to maximize social welfare. One interpretation of our result is the implementation of what is known as the "wisdom of the crowd". This topic has become increasingly relevant with the rapid spread of the Internet over the past decade. JEL classification: JEL codes:
    Date: 2013
  5. By: Macchiavello, Rocco (Department of Economics, University of Warwick)
    Abstract: Entrepreneurs must experiment to learn how good they are at a new activity. What happens when the experimentation is financed by a lender? Under common scenarios, i.e., when there is the opportunity to learn by "starting small" or when "no-compete" clauses cannot be enforced ex-post, we show that financing experi- mentation can become harder precisely when it is more profitable, i.e., for lower values of the known-arm and for more optimistic priors. Endogenous collateral requirements (like those frequently observed in micro-credit schemes) are shown to be part of the optimal contract. JEL classification: Experimentation ; Moral Hazard ; Adverse Selection ; Starting Small ; Competition JEL codes: D81 ; D86 ; G30
    Date: 2013
  6. By: Cunningham, Thomas
    Abstract: A common explanation for biases in judgment and choice has been to postulate two separate processes in the brain: a “System 1” that generates judgments automatically, but using only a subset of the information available, and a “System 2” that uses the entire information set, but is only occasionally activated. This theory faces two important problems: that inconsistent judgments often persist even with high incentives, and that inconsistencies often disappear in within-subject studies. In this paper I argue that these behaviors are due to the existence of “implicit knowledge”, in the sense that our automatic judgments (System 1) incorporate information which is not directly available to our reflective system (System 2). System 2 therefore faces a signal extraction problem, and information will not always be efficiently aggregated. The model predicts that biases will exist whenever there is an interaction between the information private to System 1 and that private to System 2. Additionally it can explain other puzzling features of judgment: that judgments become consistent when they are made jointly, that biases diminish with experience, and that people are bad at predicting their own future judgments. Because System 1 and System 2 have perfectly aligned preferences, welfare is well-defined in this model, and it allows for a precise treatment of eliciting preferences in the presence of framing effects.
    Keywords: biases, implicit knowledge, dual systems
    JEL: D11 D81
    Date: 2013–09–29
  7. By: MAEHARA Yasuhiro
    Abstract: Asymmetric information makes it difficult for small and medium enterprises (SMEs) to raise funds. In order to reduce the asymmetry of information, a framework for sharing credit risk information will be useful. Currently, sharing credit risk information on individual SMEs has been made available by credit bureaus and credit-rating firms. However, in the future, such information will not be adequate for achieving more diversified and efficient relationship and transaction-based lending. It is necessary to establish a common benchmark in the form of a credit risk index of average SMEs based on a large-scale credit risk database. Because such a credit risk database would be a public good in the information infrastructure, collaboration between the private and public sectors would be desirable.
    Date: 2013–09
  8. By: Altmann, Steffen (IZA); Falk, Armin (University of Bonn); Grunewald, Andreas (University of Bonn)
    Abstract: The behavioral relevance of non-binding default options is well established. While most research has focused on decision makers' responses to a given default, we argue that this individual decision making perspective is incomplete. Instead, a comprehensive understanding of the foundation of default effects requires taking account of the strategic interaction between default setters and decision makers. We provide a theoretical framework to analyze which default options arise in such interactions, and which defaults are more likely to affect behavior. The key drivers are the relative level of information of default setters and decision makers, and their alignment of interests. We show that default effects are more pronounced if interests of the default setter and decision makers are more closely aligned. Moreover, decision makers are more likely to follow default options the less they are privately informed about the relevant decision environment. In the second part of the paper we experimentally test the main predictions of the model. We report evidence that both the alignment of interests as well as the relative level of information are key determinants of default effects. An important policy relevant conclusion is that potential distortions arising from default options are unlikely if decision makers are either well-informed or reflect on the interests of default setters.
    Keywords: default options, libertarian paternalism, behavioral economics, incentives, laboratory experiment
    JEL: D03 D18 D83 C92
    Date: 2013–09
  9. By: Ana Fostel (Dept. of Economics, George Washington University); John Geanakoplos (Cowles Foundation, Yale University)
    Abstract: We review the theory of leverage developed in collateral equilibrium models with incomplete markets. We explain how leverage tends to boost asset prices, and create bubbles. We show how leverage can be endogenously determined in equilibrium, and how it depends on volatility. We describe the dynamic feedback properties of leverage, volatility, and asset prices, in what we call the Leverage Cycle. We also describe some cross-sectional implications of multiple leverage cycles, including contagion, flight to collateral, and swings in the issuance volume of the highest quality debt. We explain the differences between the leverage cycle and the credit cycle literature. Finally, we describe an agent based model of the leverage cycle in which asset prices display clustered volatility and fat tails even though all the shocks are essentially Gaussian.
    Keywords: Leverage, Leverage cycle, Volatility, Collateral equilibrium, Collateral value, Liquidity wedge, Flight to collateral, Contagion, Adverse selection, Agent based models
    JEL: E32 E44 G01 G12 G14 G15
    Date: 2013–09
  10. By: Mark Flood; Jonathan Katz; Stephen J Ong; Adam Smith
    Abstract: We elucidate the tradeoffs between transparency and confidentiality in the context of financial regulation. The structure of information in financial contexts creates incentives with a pervasive effect on financial institutions and their relationships. This includes supervisory institutions, which must balance the opposing forces of confidentiality and transparency that arise from their examination and disclosure duties. Prudential supervision can expose confidential information to examiners who have a duty to protect it. Disclosure policies work to reduce information asymmetries, empowering investors and fostering market discipline. The resulting confidentiality/transparency dichotomy tends to push supervisory information policies to one extreme or the other. We argue that there are important intermediate cases in which limited information sharing would be welfare-improving, and that this can be achieved with careful use of new techniques from the fields of secure computation and statistical data privacy. We provide a broad overview of these new technologies. We also describe three specific usage scenarios where such beneficial solutions might be implemented.
    Date: 2013
  11. By: Shawn Cole; Martin Kanz; Leora Klapper
    Abstract: We use an experiment with commercial bank loan officers to test how performance based compensation affects risk-assessment and lending. High-powered incentives lead to greater screening effort and more profitable lending decisions. This effect, however, is muted by deferred compensation and limited liability, two standard features of loan officer incentive contracts. We find that career concerns and personality traits affect screening behavior, but show that the response to monetary incentives does not vary with traits such as risk-aversion, optimism or overconfidence. Finally, we present evidence that incentive contracts distort the assessment of credit risk, even among trained professionals with many years of experience. Loans evaluated under permissive incentives are rated significantly less risky than the same loans evaluated under pay-for-performance.
    JEL: D03 G21 J33
    Date: 2013–09
  12. By: Chang, Chia-Ying
    Abstract: This paper sheds light on the linkages between banking crises and sudden stops and discusses the effectiveness of short-run lending in their prevention. It develops an overlapping generations framework and incorporates the possibilities of bank runs and moral hazard of financial intermediaries. Consequently, I find that the strategy to overcome liquidity problems could worsen banks’ positions and cause bank runs and sudden stops. A small liquidity shock may still lead to a banking crisis through the depositors’ expectation. A large shock would require short-run lending to prevent an immediate bank run, but the repayment obligation may worsen moral hazard problems.
    Keywords: Banking crises, Sudden stops, Moral hazard, Short-run lending, Capital flows,
    Date: 2013
  13. By: Harrison, Mark (Department of Economics and CAGE, University of Warwick Centre for Russian and East European Studies, University of Birmingham); Zaksauskienė, Inga (Vilnius University)
    Abstract: We provide the first thick description of the KGB’s counter-intelligence function in the Soviet command economy. Based on documentation from Lithuania, the paper considers KGB goals and resources in relation to the supervision of science, industry, and transport; the screening of business personnel; the management of economic emergencies; and the design of economic reforms. In contrast to a western market regulator, the role of the KGB was to enforce secrecy, monopoly, and discrimination. As in the western market context, regulation could give rise to perverse incentives with unintended consequences. Most important of these may have been adverse selection in the market for talent. There is no evidence that the KGB was interested in the costs of its regulation or in mitigating the negative consequences.
    Keywords: communism, command economy, discrimination, information,
    Date: 2013

This nep-cta issue is ©2013 by Simona Fabrizi. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
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