nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2015‒01‒19
seven papers chosen by
Guillem Roig
University of Melbourne

  1. Informational Robustness and Solution Concepts By Dirk Bergemann; Stephen Morris
  2. Strategic Incomplete Contracts: Theory and Experiments By Erkal, Nisvan; Wu, Steven Y.; Roe, Brian E.
  3. Limit pricing and secret barriers to entry By Luigi Brighi; Marcello D'Amato
  4. Does Information Feedback from In-Home Devices Reduce Electricity Use? Evidence from a Field Experiment By Shahzeen Z. Attari; Gautam Gowrisankaran; Troy Simpson; Sabine M. Marx
  5. Optimal Policy with Endogenous Signal Extraction By Andrea Lanteri; Albert Marcet; Esther Hauk
  6. International Credit Flows and Pecuniary Externalities By Markus K. Brunnermeier; Yuliy Sannikov
  7. Sequential Markets, Market Power and Arbitrage By Koichiro Ito; Mar Reguant

  1. By: Dirk Bergemann (Cowles Foundation, Yale University); Stephen Morris (Dept. of Economics, Princeton University)
    Abstract: We discuss four solution concepts for games with incomplete information. We show how each solution concept can be viewed as encoding informational robustness. For a given type space, we consider expansions of the type space that provide players with additional signals. We distinguish between expansions along two dimensions. First, the signals can either convey payoff relevant information or only payoff irrelevant information. Second, the signals can be generated from a common (prior) distribution or not. We establish the equivalence between Bayes Nash equilibrium behavior under the resulting expansion of the type space and a corresponding more permissive solution concept under the original type space. This approach unifies some existing literature and, in the case of an expansion without a common prior and allowing for payoff relevant signals, leads us to a new solution concept that we dub belief-free rationalizability.
    Keywords: Incomplete information, Informational robustness, Bayes correlated equilibrium, Interim corrrelated rationalizability, Belief free rationalizability
    JEL: C79 D82
    Date: 2014–12
  2. By: Erkal, Nisvan (University of Melbourne); Wu, Steven Y. (Purdue University); Roe, Brian E. (Ohio State University)
    Abstract: We develop a model of strategic contractual incompleteness that identifies conditions under which principals might omit even costlessly verifiable terms. We then use experiments to test comparative statics predictions of the model. While it is well known that verifiability imperfections can limit complete contracting, researchers know less about how the degree of imperfection affects endogenous incompleteness, particularly with repeat trading. In our baseline treatment with perfect verifiability, subjects overwhelmingly used complete contracts to conduct trades, achieving nearly first best outcomes. In our partial verifiability treatment with a reduced set of verifiable performance levels, the results reversed and parties relied heavily on incomplete contracts that omitted even costlessly verifiable terms. However, the efficacy of incomplete contracts in outperforming available complete contracts depends critically on the continuation probability of repeat trading. With a small continuation probability, incomplete contracts did no better than complete contracts while exposing parties to considerable strategic uncertainty.
    Keywords: incomplete contract, relational contract, endogenous incompleteness, informal incentives, experimental economics
    JEL: C73 C91 D86 J41 L14 L24 M52
    Date: 2014–12
  3. By: Luigi Brighi; Marcello D'Amato
    Abstract: We study a two periods entry game where the incumbent .rm, who has private information about his own production costs, makes a non observable long run investment choice, along with a pricing decision observed by the entrant. The investment choice affects both post-entry competition and first period cost of production, so that the cost of signaling becomes endogenous. The game is solved following Bayes-Nash requirements, the intuitive criterion is used to constrain off-equilibrium beliefs. When investment is publicly observable, it is shown that the unique intuitive equilibrium is the separating equilibrium with limit pricing and no entry deterrence. When investment is not observable, quite remarkably, there exists a unique intuitive pooling equilibrium which is Pareto superior, from the incumbent's point of view, to the unique intuitive separating equilibrium. In the pooling equilibrium no entry takes place and the price is below the low cost monopoly price. Thus, when investment is secret, a limit pricing policy supports entry deterrence. Our model provides an example of secret barriers to entry and their relationship with limit pricing. We also contribute to the analysis of a relatively under-researched class of games where the cost of signaling unobservable characteristics is endogenously determined by unobserved actions.
    Keywords: Entry deterrence, limit pricing, signaling, pooling equilibrium
    JEL: D58 L51
    Date: 2014–12
  4. By: Shahzeen Z. Attari; Gautam Gowrisankaran; Troy Simpson; Sabine M. Marx
    Abstract: There is limited evidence of behavioral changes resulting from electricity information feedback. Using a randomized control trial from a New York apartment building, we study long-term effects of information feedback from “Modlet” in-home devices, which provide near-real-time plug-level information. We find a 12–23% decrease in electricity use for treatment apartments, concentrated among individuals reporting higher willingness-to-pay for an energy monitoring system. Decrease in overall electricity use is similar among treatment apartments which received Modlets and those which declined Modlets, and does not specifically occur for outlets with Modlets. This decrease may be due to a Hawthorne or salience effect.
    JEL: D03 D12 L94 Q30 Q40 Q54
    Date: 2014–12
  5. By: Andrea Lanteri (London School of Economics); Albert Marcet (Institut d'Anàlisi Econòmica CSIC, BGS); Esther Hauk (Spanish Research Council)
    Abstract: This paper studies optimal policy in models with multidimensional uncertainty and endogenous observables. We first consider a very general setup where the policy-maker does not observe the realisations of the shocks that hit the economy, but only some aggregate variables that are endogenous with respect to policy, therefore standard first order conditions do not hold. We derive first order conditions of optimality from first principles and we illustrate why the estimation of the state of the economy cannot be separated from the determination of the optimal policy. In an optimal fiscal policy application with incomplete markets and endogenous Partial Information, we find that the optimal policy response to aggregate data can be quite non-linear: it calls for tax smoothing across states in normal times, but in some cases for a strong adjustment of fiscal positions during a slump. We show that policies that disregard the endogeneity of the filtering problem and hence these non-linearities can be quite wrong. Finally, our model can rationalise the fiscal response of some European countries to the Great Recession: a slow reaction, followed by large deficits and a delayed sharp fiscal adjustment that protracts the downturn.
    Date: 2014
  6. By: Markus K. Brunnermeier; Yuliy Sannikov
    Abstract: This paper develops a dynamic two-country neoclassical stochastic growth model with incomplete markets. Short-term credit flows can be excessive and reverse suddenly. The equilibrium outcome is constrained inefficient due to pecuniary externalities. First, an undercapitalized country borrows too much since each firm does not internalize that an increase in production capacity undermines their output price, worsening their terms of trade. From an ex-ante perspective each firm undermines the natural “terms of trade hedge.” Second, sudden stops and fire sales lead to sharp price drops of illiquid capital. Capital controls or domestic macro-prudential measures that limit short-term borrowing can improve welfare.
    JEL: F32 F43 G15 O41
    Date: 2014–12
  7. By: Koichiro Ito; Mar Reguant
    Abstract: We develop a theoretical framework to characterize strategic behavior in sequential markets under imperfect competition and limited arbitrage. Our theory predicts that these two elements can generate a systematic price premium. We test the model predictions using micro-data from the Iberian electricity market. We show that the observed price differences and firm behavior are consistent with the model. Finally, we quantify the welfare effects of arbitrage using a structural model. In our setting, we show that full arbitrage is not necessarily welfare-enhancing in the presence of market power, reducing consumer costs but decreasing productive efficiency.
    JEL: D43 L13 L94 Q40
    Date: 2014–12

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