nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2016‒03‒10
three papers chosen by
Guillem Roig
University of Melbourne

  1. Breaking the Spell with Credit-Easing: Self-Confirming Credit Crises in Competitive Search Economies By Gaballo, Gaetano; Marimon, Ramon
  2. Asymmetric information in the regulation of the access to markets By Simone Ghislandi; Michael Kuhn
  3. Can Fixed-Term Contracts Put Low Skilled Youth on a Better Career Path? Evidence from Spain By Garcia Perez, J. Ignacio; Marinescu, Ioana E.; Vall-Castello, Judit

  1. By: Gaballo, Gaetano; Marimon, Ramon
    Abstract: We show that credit crises can be Self-Confirming Equilibria (SCE), which provides a new rationale for policy interventions like, for example, the FRB's TALF credit-easing program in 2009. We introduce SCE in competitive credit markets with directed search. These markets are efficient when lenders have correct beliefs about borrowers' reactions to their offers. Nevertheless, credit crises - where high interest rates self-confirm high credit risk - can arise when lenders have correct beliefs only locally around equilibrium outcomes. Policy is needed because competition deters the socially optimal degree of information acquisition via individual experiments at low interest rates. A policy maker with the same beliefs as lenders will find it optimal to implement a targeted subsidy to induce low interest rates and, as a by-product, generate new information for the market. We provide evidence that the 2009 TALF was an example of such Credit Easing policy. We collect new micro-data on the ABS auto loans in the US before and after the policy intervention, and we test, successfully, our theory in this case.
    Keywords: credit crisis; directed search; learning; self-confirming equilibrium; social experimentation; unconventional policies
    JEL: D53 D83 D84 D92 E44 E61 G01 G20 J64
    Date: 2016–02
  2. By: Simone Ghislandi (Department of Socioeconomics, Vienna University of Economics and Business); Michael Kuhn (Wittgenstein Centre, Vienna Institute of Demography)
    Abstract: It is frequently argued that the high costs of clinical trials prior to the admission of new pharmaceuticals are stifling innovation. At the same time, regulation of the access to markets is often justified on the basis of consumers’ inability to detect the true quality of a product. We examine these arguments from an information economic perspective by setting a framework where the incentives to invest in R&D are influenced by the information structure prevailing when the product is launched in the market at a later stage. In this setting, by changing the information structure, regulation (or the lack of) can thus indirectly affect R&D efforts. More formally, we construct a moral hazard – cum – adverse selection model in which a pharmaceutical firm exerts an unobservable effort towards developing an innovative (high quality) drug (moral hazard) and then announces the (unobservable) quality outcome to an uninformed regulator and/or consumers (adverse selection). We compare the outcomes in regard to innovation effort and expected welfare under two regimes: (i) regulation, where products undergo a clinical trial designed to ascertain product quality at the point of market access; and (ii) laissez-faire with free entry, where the revelation of quality is left to the market process. Results show that whether or not innovation is greater in the presence of entry regulation crucially depends on the efficacy of the trial in identifying (poor) quality, on the probability that unknown qualities are revealed in the market process, and on the preference and cost structure. The welfare ranking of the two regimes depends on the differential effort incentive and on the net welfare gain from implementing full information instantaneously. For example, in settings of vertical monopoly, vertical differentiation and horizontal differentiation with no variable cost of quality, entry regulation tends to be the preferred regime if the effort incentive under pooling is relatively low and profits do not count too much towards welfare. A complementary numerical analysis shows how the outcomes vary with the market and cost structure.
    Keywords: adverse selection, (entry) regulation, moral hazard, pharmaceutical industry, R&D incentives
    JEL: D82 I18 L15 L51 O31
    Date: 2016–02
  3. By: Garcia Perez, J. Ignacio (Universidad Pablo de Olavide); Marinescu, Ioana E. (Harris School, University of Chicago); Vall-Castello, Judit (Universitat Pompeu Fabra)
    Abstract: By reducing the commitment made by employers, fixed-term contracts can help low-skilled youth find a first job. However, the long-term impact of fixed-term contracts on these workers' careers may be negative. Using Spanish social security data, we analyze the impact of a large liberalization in the regulation of fixed-term contracts in 1984. Using a cohort regression discontinuity design, we find that the reform raised the likelihood of male high-school dropouts working before age 19 by 9%. However, in the longer run, the reform reduced number of days worked (by 4.5%) and earnings (by 9%).
    Keywords: temporary contracts, long-term impact, labour market career
    JEL: J08
    Date: 2016–02

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