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on Contract Theory and Applications |
| By: | Richard P. McLean (Department of Economics, Rutgers University); Andrew Postlewaite (Department of Economics, University of Pennsylvania) |
| Abstract: | We showed in McLean and Postlewaite (2014) that when agents are informationally small, there exist small modifications to VCG mechanisms in interdependent value problems that restore incentive compatibility. This paper presents a two-stage mechanism that similarly restores incentive compatibility. The first stage essentially elicits that part of the agents’ private information that induces interdependence and reveals it to all agents, transforming the interdependent value problem into a private value problem. The second stage is a VCG mechanism for the now private value problem. Agents typically need to transmit substantially less information in the two stage mechanism than would be necessary for a single stage mechanism. Lastly, the firrst stage that elicits the part of the agents’ private information that induces interdependence can be used to transform certain other interdependent value problems into private value problems. |
| Keywords: | Auctions, Incentive Compatibility, Mechanism Design, Interdependent Values, Ex Post Incentive Compatibility, Informational Size |
| JEL: | C70 D44 D60 D82 |
| Date: | 2015–03–04 |
| URL: | http://d.repec.org/n?u=RePEc:pen:papers:15-011&r=cta |
| By: | Benjamin Falkeborg (Department of Economics, University of Copenhagen) |
| Abstract: | I study the implications of agency frictions for the pricing policy of institutional market makers. In a setting where a market maker cannot observe the actions of an employed trader, I derive the optimal compensation structure and pricing policy. The theory demonstrates that incentive contracting and the price for immediacy are inherently linked. When the trader’s compensation is optimally deferred according to order flow, market making efficiency is improved and the quoted spreads are minimized. In other words, optimizing trader compensation leads to a liquidity gain. |
| Keywords: | Market Making, Hedging, Dynamic Moral Hazard, Recursive Contracts, Liquidity Provision. |
| JEL: | D81 D86 G12 J33 |
| Date: | 2015–02–27 |
| URL: | http://d.repec.org/n?u=RePEc:kud:kuiedp:1504&r=cta |
| By: | Crawford, Gregory S; Pavanini, Nicola; Schivardi, Fabiano |
| Abstract: | We measure the consequences of asymmetric information and imperfect competition in the Italian market for small business lines of credit. We provide evidence that a bank’s optimal price response to an increase in adverse selection varies depending on the degree of competition in its local market. More adverse selection causes prices to increase in competitive markets, but can have the opposite effect in more concentrated ones, where banks trade off higher markups and the desire to attract safer borrowers. This implies both that imperfect competition can moderate the welfare losses from an increase in adverse selection, and that an increase in adverse selection can moderate the welfare losses from market power. Exploiting detailed data on a representative sample of Italian firms, the population of medium and large Italian banks, individual lines of credit between them, and subsequent defaults, we estimate models of demand for credit, loan pricing, loan use, and firm default to measure the extent and consequences of asymmetric information in this market. While our data include a measure of observable credit risk 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. We find evidence of adverse selection in the data, and increase it with a policy experiment to evaluate its importance. As predicted, in the counterfactual equilibrium prices rise in more competitive markets and decline in more concentrated ones, where we also observe an increase in access to credit and a reduction in default rates. Thus market power may serve as a shield against the negative effects of an increase in adverse selection. |
| Keywords: | assymetric information; credit markets; imperfect competition; lending markets |
| JEL: | G14 G21 L13 |
| Date: | 2015–03 |
| URL: | http://d.repec.org/n?u=RePEc:cpr:ceprdp:10473&r=cta |
| By: | Maija Halonen-Akatwijuka; Oliver Hart |
| Abstract: | Parties often regulate their relationships through “continuing” contracts that are neither long-term nor short-term but usually roll over. We study the trade-off between long-term, short-term, and continuing contracts in a two period model where gains from trade exist in the first period, and may or may not exist in the second period. A long-term contract that mandates trade in both periods is disadvantageous since renegotiation is required if there are no gains from trade in the second period. A short-term contract is disadvantageous since a new contract must be negotiated if gains from trade exist in the second period. A continuing contract can be better. In a continuing contract there is no obligation to trade in the second period but if there are gains from trade the parties will bargain “in good faith” using the first period contract as a reference point. This can reduce the cost of negotiating the next contract. Continuing contracts are not a panacea, however, since good faith bargaining may preclude the use of outside options in the bargaining process and as a result parties will sometimes fail to trade when this is efficient. |
| JEL: | D23 D86 K12 |
| Date: | 2015–03 |
| URL: | http://d.repec.org/n?u=RePEc:nbr:nberwo:21005&r=cta |
| By: | An, Yonghong; Tang, Xun |
| Abstract: | We introduce a structural model of procurement auctions with incomplete contracts, where a procurer chooses an initial project specification endogenously. The contract between the procurer and the winner of the auction is incomplete in that the two parties may agree to adopt a new feasible specification later, and negotiate an additional transfer via Nash Bargaining where both parties’ disagreement values depend on the auction price. In a Perfect Bayesian Equilibrium, contractors competing in the auction take account of such incompleteness while quoting prices. We show that the model primitives are non-parametrically identified and propose a feasible estimation procedure. Using data from highway procurement auctions in California, we estimate the structural elements that determine the hold-up due to incompleteness, and infer how a contractor’s bargaining power and the mark-up in the price quoted vary with its characteristics and the features of the construction project. We also find that ignoring the existence of contract incompleteness in the structural analysis of the bidding data leads to substantial over-estimation of the mark-ups in the prices. |
| Keywords: | Identification, estimation, incomplete contracts, procurement auctions |
| JEL: | C14 D44 |
| Date: | 2015–02 |
| URL: | http://d.repec.org/n?u=RePEc:pra:mprapa:62602&r=cta |
| By: | Benito Arruñada |
| Abstract: | I analyze the basis of the market economy in classical Rome, from the perspective of personal-versus-impersonal exchange and focusing on the role of the state in providing market-enabling institutions. I start by reviewing the central conflict in all exchanges between those holding and those acquiring property rights, and how solving it requires reducing information asymmetry without endangering the security of property. Relying on a model of the social choice of institutions, I identify the demand and supply factors driving the institutional choices made by the Romans, and examine the economic circumstances that influenced these factors in the classical period of Roman law. Comparing the predictions of the model with the main solutions used by Roman law in the areas of property, business exchange and the enforcement of personal obligations allows me to propose alternative interpretations for some salient institutions that have been subject to controversy in the literature, and to conclude with an overall positive assessment of the market-enabling role of the Roman state. |
| Keywords: | property rights, enforcement, transaction costs, registries, Roman law, impersonal exchange, personal exchange, New Institutional Economics, Law and Economics. |
| JEL: | D1 D23 G38 K11 K12 K14 K22 K36 L22 N13 O |
| Date: | 2015–03 |
| URL: | http://d.repec.org/n?u=RePEc:upf:upfgen:1471&r=cta |
| By: | Guy Meunier (INRA-UR1303 ALISS); Jean-Pierre Ponssard (CNRS); Francisco Ruiz-Aliseda (Ecole Polytechnique) |
| Abstract: | In industries with large sunk costs, the investment strategy of firms depends on the regulatory context. We consider ex-ante industrial policies in which the sunk cost may be either taxed or subsidized, and antitrust policies which could either be pro-competitive (leading to divestiture in case of high ex-post profitability) or lenient (allowing mergers in case of low ex-post profitability). Through a simple entry game we completely characterize the impact of these policies and examine their associated dynamic trade-offs between the timing of the investment, the ex-post benefits for the consumers, and the possible duplication of fixed costs. We find that merger policies are dominated by ex-ante industrial policies, whereas the latter are dominated by divestiture policies only under very special circumstances. |
| Keywords: | entry, industry dynamic, antitrust policy, divestiture |
| JEL: | L1 L4 L5 |
| Date: | 2015–03 |
| URL: | http://d.repec.org/n?u=RePEc:ali:wpaper:2015-01&r=cta |