nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2013‒12‒15
twenty papers chosen by
Simona Fabrizi
Massey University, Albany

  1. Hidden insurance in a moral hazard economy By Bertola, Giuseppe; Koeniger, Winfried
  2. A Theory of Contracts with Limited Enforcement By David Martimort; Aggey Semenov; Lars Stole
  3. Commitment without Reputation: Renegotiation-Proof Contracts under Asymmetric Information By Emanuele Gerratana; Levent Koçkesen
  4. Deceptive Advertising with Rational Buyers By Giovanni Ursino; Salvatore Piccolo; Piero Tedeschi
  5. Do Not Panic: How to Avoid Inefficient Rushes Using Multi-Stage Auctions By Angel Hernando-Veciana; Fabio Michelucci
  6. Becoming “We” instead of “I” : Identity management and incentives in the workplace By Jocelyn Donze; Trude Gunnes
  7. Central bank Transparency and Information Dissemination : An experimental Approach By Emna Trabelsi; Walid Hichri
  8. Markov Games with Frequent Actions and Incomplete Information By Cardaliaguet, Pierre; Rainer, Catherine; Rosenberg, Dinah; Vieille , Nicolas
  9. Information, Interdependence, and Interaction: Where Does the Volatility Come From? By Dirk Bergemann; Tibor Heumann; Stephen Morris
  10. Imperfect Knowledge About Asset Prices and Credit Cycles By Pei Kuang
  11. Bargaining over a Divisible Good in the Market for Lemons By Dino Gerardi; Lucas Maestri
  12. On Games of Strategic Experimentation By Rosenberg, Dinah; Salomon , Antoine; Vieille , Nicolas
  13. Approximate Implementation in Markovian Environments By Renou , Ludovic; Tomala, Tristan
  14. Assortative matching through signals By Friedrich Poeschel
  15. Physician Overtreatment and Undertreatment with Partial Delegation By Dmitry Lubensky; Eric Schmidbauer
  16. Adverse selection and risk adjustment under imperfect competition By Normann Lorenz
  17. Limited Liability, Moral Hazard and Risk Taking A Safety Net Game Experiment By Tibor Neugebauer,; Sascha Fullbrunn
  18. Simultaneous auctions for complementary goods By Wiroy Shin
  19. Chasing Noise By Brock Mendel; Andrei Shleifer
  20. Varying the number of bidders in the first-price sealed-bid auction: experimental evidence for the one-shot game By Tibor Neugebauer; Sascha Fllbrunn

  1. By: Bertola, Giuseppe; Koeniger, Winfried
    Abstract: We consider an economy where individuals privately choose effort and trade competitively priced securities that pay off with effort-determined probability. We show that if insurance against a negative shock is sufficiently incomplete, then standard functional formrestrictions ensure that individual objective functions are optimized by an effort and insurance combination that is unique and satisfies first- and second-order conditions. Modeling insurance incompleteness in terms of costly production of private insurance services, we characterize the constrained inefficiency arising in general equilibrium from competitive pricing of nonexclusive financial contracts. --
    Keywords: Hidden action,Principal agent,First-order approach,Constrained efficiency
    JEL: E21 D81 D82
    Date: 2013
  2. By: David Martimort (Paris School of Economics-EHESS); Aggey Semenov (Department of Economics, University of Ottawa, Ottawa, ON); Lars Stole (University of Chicago Booth School of Business)
    Abstract: We present a Theory of Contracts under costly enforcement in the context of a dynamic relationship between an uninformed buyer and a seller who is privately informed on his persistent cost at the outset. Public enforcement relies on remedies for breach. Private enforcement comes from severing relationships. We first characterize aggregate enforcement constraints ensuring that trading partners do not breach contracts unduly. Whether a long-term contract is enforceable does not depend on the distribution of penalties for breach between the buyer and the seller. While under complete information, the optimal contract would remain stationary, non-stationarity might arise under asymmetric information. Enforcement constraints are time-dependent and easier to satisfy as time passes. Indeed, a high-cost seller may be tempted to trade high volumes at high prices at the beginning of the relationship before breaching the contract later on. Yet, such take-the-money-and-run strategy becomes less attractive as time passes and can be prevented with back loaded payments. The optimal contract thus goes through two different phases. First, quantities and prices increase at the inception of the relationship. Later on, the contract looks more stationary. Long-run screening distortions encapsulate the quality of enforcement, offering de facto a link between the quality of the legal system and contractual performances.
    Keywords: Asymmetric information, enforcement, breach of contracts, dynamic contracts
    JEL: D82 D86 K2
    Date: 2013
  3. By: Emanuele Gerratana (SIPA, Columbia University); Levent Koçkesen (Department of Economics, Koç University)
    Abstract: This paper characterizes equilibrium outcomes of extensive form games with incomplete information in which players can sign renegotiable contracts with third-parties. Our aim is to understand the extent to which third-party contracts can be used as commitment devices when it is impossible to commit not to renegotiate them. We characterize renegotiation-proof contracts and strategies for general extensive form games with incomplete information and apply our results to two-stage games. If contracts are observable, then the second mover obtains her best possible payoff given that she plays a renegotiation-proof strategy and the first mover best responds. If contracts are unobservable, then a “folk theorem” type result holds: Any outcome in which the second mover best responds to the first mover’s action on the equilibrium path and the first mover receives at least his “individually rational payoff”, can be supported. We also apply our results to games with monotone externalities and to a model of credibility of monetary policy and show that in both cases renegotiation-proofness imposes a very simple restriction.
    Keywords: Third-Party Contracts, Commitment, Strategic Delegation, Renegotiation, Asymmetric Information, Renegotiation-Proofness, Entry-Deterrence,Monetary Policy.
    JEL: C72 D80 L13
    Date: 2013–12
  4. By: Giovanni Ursino (Università Cattolica del Sacro Cuore); Salvatore Piccolo (Università Cattolica delSacro Cuore di Milano and CSEF); Piero Tedeschi (Università Cattolica del Sacro Cuore)
    Abstract: We study a Bertrand game where two sellers supplying products of different and unverifiable qualities can outwit potential clients through (costly) deceptive advertising. We characterize a class of pooling equilibria where sellers post the same price regardless of their quality and low quality ones deceive buyers. Although in these equilibria low quality goods are purchased with positive probability, the buyer’s (expected) utility can surprisingly be higher than in a fully separating equilibrium, which suggests that (absent price regulation) a per se rule banning deceptive practices may harm consumers. We also argue that sellers invest more in deceptive advertising the better their reputation vis-à-vis potential clients – i.e., firms that are better trusted by customers, have greater incentives to invest in deceptive advertising. Finally, we characterize the optimal monitoring effort exerted by a regulatory agency who seeks to identify and punish deceptive practices. We show that consumer surplus maximization requires a higher monitoring e¤ort than social welfare maximization.
    Keywords: Misleading Advertising, Deception, Bayesian Consumers, Asymmetric Information
    JEL: L13 L15 L4
    Date: 2013–12–10
  5. By: Angel Hernando-Veciana; Fabio Michelucci
    Abstract: We show that open ascending auctions are prone to inecient rushes, i.e. all bidders quitting at the same price, in market environments such as privatizations, takeover contests, and procurement auctions. Rushes arise when an incumbent with better information about a common value component of the asset for sale quits, and his exit reveals negative information. Rushes can be avoided, and expected social surplus maximized, by reducing the disclosure of information with the use of a multi-stage auction. Thus, our results point out to an important limitation of market mechanisms that provide immediate information disclosure to all agents in a market.
    Keywords: efficiency; auctions; mechanism design; two stage mechanisms;
    JEL: D44 D82
    Date: 2013–08
  6. By: Jocelyn Donze; Trude Gunnes (Statistics Norway)
    Abstract: This article studies how a firm fosters formal and informal interaction among its employees to create a collective identity and positively influence their effort. We develop an agency model, in which employees have both a personal and a social ideal for effort. The firm does not observe the personal ideals, which gives rise to an adverse selection problem, but can make its workforce more sensitive to the social ideal by allocating part of working hours to social interaction. We show that there are two reasons why the firm invests in social capital. First, it reinforces the effectiveness of monetary incentives. Second, by creating a shared identity in the workforce, the firm is able to reduce the adverse selection problem. We also show that the firm allocates more time to bonding activities when employees have low personal ideals for effort or when they are more heterogeneous as regards these ideals.
    Keywords: Agency theory; Social interaction; Social norms; norm regulation
    JEL: D2 D8 J3 M5
    Date: 2013–10
  7. By: Emna Trabelsi (ISG - Institut Supérieur de Gestion de Tunis - Université de Tunis); Walid Hichri (GATE Lyon Saint-Étienne - Groupe d'analyse et de théorie économique - CNRS : UMR5824 - Université Lumière - Lyon II - École Normale Supérieure (ENS) - Lyon - PRES Université de Lyon)
    Abstract: In this paper, we propose to compare different partial transparency regimes in order to determine the optimal diessemination policy by the central bank, using an experimental approach. A treatment dedicated to the benchmark situation (where information is fully released) is also available. Our experiment is based on subsequent framework of Morris and Shin (2002), Cornand and Heinemann (2008) and Trabelsi (2012). The predictive power of K-level reasoning is an issue that is addressed also in this paper. Our experiment indicates that -when fully disclosed- players overreact to public information and this overreaction is efficiently reduced when the degree of publicity decreases (i.e. when the fragmentation measure increases). The average weight assigned to common signal decreases over treatments, especially when we establish partial transparent strategy (i.e. fragmented information). The results provide support both for and against global games theoretical predictions. In fact, although players overreact to public signal, their behavior is inconsistent with theoretical equilibrium, which means that the destabilizing effect of public information is less pronounced experimentally than when it does in theory. This is not the case when public information is fragmented ; subjects' behavior does approach equilibrium. These observations coincide with both a collective and an individual analyses of behavior.
    Keywords: Central bank transparency; coordination games; semi-public information; private information; experimental economics
    Date: 2013–12–09
  8. By: Cardaliaguet, Pierre; Rainer, Catherine; Rosenberg, Dinah; Vieille , Nicolas
    Abstract: We study a two-player, zero-sum, stochastic game with incomplete information on one side in which the players are allowed to play more and more frequently. The informed player observes the realization of a Markov chain on which the payoffs depend, while the non-informed player only observes his opponent's actions. We show the existence of a limit value as the time span between two consecutive stages vanishes; this value is characterized through an auxiliary optimization problem and as the solution of an Hamilton-Jacobi equation.
    Keywords: stochastic; zero sum; Markov chain; Hamilton-Jacobi equation; incomplete information
    JEL: C00
    Date: 2013–10–24
  9. By: Dirk Bergemann (Cowles Foundation, Yale University); Tibor Heumann (Dept. of Economics, Yale University); Stephen Morris (Dept. of Economics, Princeton University)
    Abstract: We analyze a class of games with interdependent values and linear best responses. The payoff uncertainty is described by a multivariate normal distribution that includes the pure common and pure private value environment as special cases. We characterize the set of joint distributions over actions and states that can arise as Bayes Nash equilibrium distributions under any multivariate normally distributed signals about the payoff states. We characterize maximum aggregate volatility for a given distribution of the payoff states. We show that the maximal aggregate volatility is attained in a noise-free equilibrium in which the agents confound idiosyncratic and common components of the payoff state, and display excess response to the common component. We use a general approach to identify the critical information structures for the Bayes Nash equilibrium via the notion of Bayes correlated equilibrium, as introduced by Bergemann and Morris (2013b).
    Keywords: Incomplete information, Bayes correlated equilibrium, Volatility, moments restrictions, Linear best responses, Quadratic payoffs
    JEL: C72 C73 D43 D83
    Date: 2013–12
  10. By: Pei Kuang
    Abstract: This paper develops an equilibrium model with a housing collateral constraint in which rational agents are uncertain about the collateral price process. Bayesian learning by agents can endogenously generate booms and busts in collateral prices and significantly strengthen the role of the collateral constraint as an amplification mechanism through the interaction of agents' price beliefs, price realizations and credit limits. Over-optimism or pessimism is fueled when a surprise in price expectations is interpreted partially by the agents as a permanent change in the parameters governing the collateral price process and is validated by subsequently realized prices. The learning model can quantitatively account for the recent US boom-bust cycle in house prices, household debt and aggregate consumption dynamics during 2001-2008. The paper also demonstrates that the leveraged economy with a higher steady state leverage ratio is more prone to self-inforcing learning dynamics.
    Keywords: Boom-Bust, Collateral Constraints, Learning, Leverage, Housing
    JEL: D83 D84 E32 E44
    Date: 2013–11
  11. By: Dino Gerardi; Lucas Maestri
    Abstract: A seller dynamically sells a divisible good to a buyer. It is common knowledge that there are gains from trade and that the gains per unit are decreasing. Payoffs are interdependent as in Akerlof's market for lemons. The seller is informed about the good's quality. The buyer makes an offer in every period and learns about the good's quality only through the seller's behavior. We characterize the stationary equilibrium when the time between offers is small. The owner of a high-quality good sells it in dribs and drabs, whereas the owner of a low-quality good constantly randomizes between selling small pieces and accepting an offer for all the remaining units. We use this characterization to analyze the limiting equilibrium outcome as the good becomes more divisible. We prove that there is slow trading: a valuable good is smoothly sold over time. In contrast, the good is never partially sold when gains per unit are increasing.
    JEL: C78 D82
    Date: 2013
  12. By: Rosenberg, Dinah; Salomon , Antoine; Vieille , Nicolas
    Abstract: We study a class of symmetric strategic experimentation games. Each of two players faces a (exponential) two-armed bandit problem, and must decide when to stop experimenting with the risky arm. The equilibrium amount of experimentation depends on the degree to which experimentation outcomes are observed, and on the correlation between the two individual bandit problems. When experimentation outcomes are public, the game is basically one of strategic complementarities. When experimentation decisions are public, but outcomes are private, the strategic interaction is more complex. We fully characterize the equilibrium behavior in both informational setups, leading to a clear comparison between the two. In particular, equilibrium payoffs are higher when equilibrium outcomes are public.
    Keywords: symmetric strategic experimentation games; equilibrium; strategic experimentation
    JEL: C00
    Date: 2013–10–24
  13. By: Renou , Ludovic; Tomala, Tristan
    Abstract: This paper considers dynamic implementation problems with evolving private information (according to Markov processes). A social choice function is approximately implementable if there exists a dynamic mechanism such that the social choice function is implemented by an arbitrary large number of times with arbitrary high probability in every communication equilibrium. We show that if a social choice function is strictly efficient in the set of social choice functions that satisfy an undetectable condition, then it is approximately implementable. We revisit the classical monopolistic screening problem and show that the monopolist can extract the full surplus in almost all periods with arbitrary high probability.
    Keywords: implementation; Markov Process; undetectability; efficiency
    JEL: C70
    Date: 2013–07–21
  14. By: Friedrich Poeschel
    Abstract: When agents do not know where to find a match, they search. However, agents could direct their search to agents who strategically choose a certain signal. Introducing cheap talk to a model of sequential search with bargaining, we find that signals will be truthful if there are mild complementarities in match production: supermodularity of the match production function is a necessary and sufficient condition. It simultaneously ensures perfect positive assortative matching, so that single-crossing property and sorting condition coincide. As the information from signals allows agents to avoid all unnecessary search, this search model exhibits nearly unconstrained efficiency.
    JEL: J64 D83 C78
    Date: 2013–12–07
  15. By: Dmitry Lubensky (Department of Business Economics and Public Policy, Indiana University Kelley School of Business); Eric Schmidbauer (Department of Business Economics and Public Policy, Indiana University Kelley School of Business)
    Abstract: The physician induced demand literature finds that doctors tend to overtreat patients for financial gain. We analyze this phenomenon when patients are rationally skeptical of doctor's motives and can reject a proposed treatment. We find the classic physician induced demand approach understates patient's welfare loss: treatment on average is excessive but also less medically appropriate, and the latter effect may dominate. Inappropriate treatment arises from the doctor's strategic misdiagnosis to forestall rejection, but this problem can be attenuated by insurance which better aligns incentives and improves communication. We resolve an open question in the partial delegation literature by showing that a generalization of the Krishna and Morgan (2001) equilibrium is the most informative equilibrium that survives the intuitive criterion in a setting that nests both our and their model.
    Keywords: physician induced demand, over-utilization, non-compliance, partial delegation, cheap talk
    JEL: L0 D82 I10
    Date: 2013–11
  16. By: Normann Lorenz
    Abstract: This paper analyzes the distortions of health insurers’ benefit packages due to adverse selection when there is imperfect competition. Within a discrete choice setting with two risk types, the following main results are derived: For intermediate levels of competition, the benefit packages of both risk types are distorted in the separating equilibrium. As the level of competition decreases, the distortion decreases for the low risk type, but increases for the high risk type; in addition, the number of insurers offering the benefit package for the low risk type increases. If the level of competition is low enough, a pooling equilibrium emerges, which generally differs from the Wilson-equilibrium. It is shown that these results have important implications for risk adjustment: For intermediate levels of competition, risk adjustment can be ineffective or even decrease welfare if it is not reasonably precise.
    Keywords: Adverse selection, discrete choice, risk adjustment
    JEL: I18
    Date: 2013
  17. By: Tibor Neugebauer,; Sascha Fullbrunn (LSF)
    Abstract: We model the safety net problem as a social dilemma game involving moral hazard, risk taking and limited liability. The safety net game is compared to both an individual decision task involving full liability and the deterministic public goods game. We report experimental data to show that limited "liability leads to higher risk taking in comparison to full liability;" nevertheless, the difference is much smaller than predicted by theory. In the safety net game, subjects behave as if socially responsible for the losses they impose on the group. With repetition, nevertheless, a gradual emergence of the moral hazard problem arises.
    Keywords: Forthcoming: Economic Inquiry
    JEL: C9 D7 D8 H4 I1 I3
    Date: 2012
  18. By: Wiroy Shin
    Abstract: This paper studies an environment of simultaneous, separate, first-price auctions for complementary goods. Agents observe private values of each good before making bids, and the complementarity between goods is explicitly incorporated in their utility. For simplicity, a model is presented with two first-price auctions and two bidders. We show that a monotone pure-strategy Bayesian Nash Equilibrium exists in the environment.
    Date: 2013–12
  19. By: Brock Mendel; Andrei Shleifer
    Abstract: We present a simple model in which rational but uninformed traders occasionally chase noise as if it were information, thereby amplifying sentiment shocks and moving prices away from fundamental values. In the model, noise traders can have an impact on market equilibrium disproportionate to their size in the market. The model offers a partial explanation for the surprisingly low market price of financial risk in the spring of 2007. Copyright 2011 Elsevier B.V. All rights reserved.
  20. By: Tibor Neugebauer; Sascha Fllbrunn (LSF)
    Abstract: The paper reports experimental data on the behavior in the first-price sealed-bid auction for a varying number of bidders when values and bids are private information. This feedback-free design is proposed for the experimental test of the one-shot game situation. We consider both within-subject and betweensubjects variations. In line with the qualitative risk neutral Nash equilibrium prediction, the data show that bids increase in the number of bidders. However, in auctions involving a small number of bidders, average bids are above, and in auctions involving a larger number of bidders, average bids are below the risk neutral equilibrium prediction. The quartile analysis reveals that bidding behavior is not constant across the full value range for a given number of bidders. On the high value quartiles, however, the average bid-value ratio is not different from the risk neutral prediction. The behavior is different when the winning bid is revealed after each repetition.
    Date: 2013

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