nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2016‒06‒18
six papers chosen by
Guillem Roig
University of Melbourne

  1. The Design of Optimal Collateralized Contracts By Dan Cao; Roger Lagunoff
  2. Regulatory Holidays and Optimal Network Expansion By Willems, Bert; Zwart, Gijsbert
  3. Microcredit Contracts, Risk Diversification and Loan Take-Up By Attanasio, O.; Augsburg, B.; de Haas, Ralph
  4. Markets, contracts, and uncertainty in a groundwater economy By Gine,Xavier; Jacoby,Hanan G.
  5. Leveraging Dominance with Credible Bundling By Hurkens, Sjaak; Jeon, Doh-Shin; Menicucci, Domenico
  6. The Joy of Flying: Efficient Airport PPP contracts By Eduardo Engel; Ronald Fischer; Alexander Galetovic

  1. By: Dan Cao (Department of Economics, Georgetown University); Roger Lagunoff (Department of Economics, Georgetown University)
    Abstract: This paper presents a two-period optimal contracting model of collateral. A borrower values a capital good and a composite non-capital good. He privately observes an income shock in the composite good in the second period. Collateralization of both goods occurs in the optimal contract, whereas it does not under full information. Relative to full information, the capital good in the optimal contract is over-consumed in the initial loan period and under-consumed in the repayment period. The relation between forfeiture of assets and contractual distortion is summarized by a formula showing higher distortions associated with larger increases in forfeited collateral. Forfeiture is decreasing in income at the tails of the income distribution, and low income types forfeit more than high income types. We obtain a closed form solution in a parameterized model. Forfeited collateral is globally decreasing in income with pooling at the bottom when the borrower's initial assets are low.
    Keywords: Optimal contract, asymmetric information, collateral, forfeiture, collateralized contract.
    JEL: D82 D86 D53 D14 G21 G22
    Date: 2016–04–01
  2. By: Willems, Bert (Tilburg University, TILEC); Zwart, Gijsbert (Tilburg University, TILEC)
    Abstract: We model the optimal regulation of continuous, irreversible, capacity expansion, in a model in which the regulated network firm has private information about its capacity costs, investments need to be financed out of the firm’s cash flows from selling network access and demand is stochastic. If asymmetric information is large, the optimal mechanism consists of a regulatory holiday for low-cost firms, and a mark-up regime for higher-cost rms. With the regulatory holiday, a firm receives the full revenue of capacity sales, and expands capacity as if it were an unregulated monopolist. Under the mark-up regime, a firm receives only a fraction of the capacity revenues, and is obliged to expand capacity whenever the price for capacity reaches a threshold. The regulatory holiday is necessary to fund information rents to the most efficient firms, which invest relatively early, as direct investment subsidies are not feasible.
    Keywords: regulatory holiday; real option value; asymmetric information; optimal contracts
    JEL: D81 D82 L52
    Date: 2016
  3. By: Attanasio, O.; Augsburg, B.; de Haas, Ralph (Tilburg University, Center For Economic Research)
    Abstract: We study theoretically and empirically the demand for microcredit under different liability arrangements and risk environments. A simple theoretical model shows that the demand for joint-liability loans can exceed that for individual-liability loans when risk-averse borrowers value their long-term relationship with the lender. Joint liability then offers a way to diversify risk and to reduce the chance of losing access to future loans. We also show that the demand for loans depends negatively on the riskiness of projects. Using data from a randomized controlled trial in Mongolia we find that these model predictions hold true empirically. In particular, we use innovative data on subjective risk perceptions to show that expected project risk negatively affects the demand for loans. In line with an insurance role of joint-liability contracts, this effect is muted in villages where joint-liability loans are available.
    Keywords: microcredit; joint liability; loan take-up; risk diversification
    JEL: D14 D81 D86 G21 O16
    Date: 2016
  4. By: Gine,Xavier; Jacoby,Hanan G.
    Abstract: Groundwater is a vital yet threatened resource in much of South Asia. This paper develops a model of groundwater transactions under payoff uncertainty arising from unpredictable fluctuations in groundwater availability during the agricultural dry season. The model highlights the trade-off between the ex post inefficiency of long-term contracts and the ex ante inefficiency of spot contracts. The structural parameters are estimated using detailed micro-data on the area irrigated under each contract type combined with subjective probability distributions of borewell discharge elicited from a large sample of well-owners in southern India. The findings show that, while the contracting distortion leads to an average welfare loss of less than 2 percent and accounts for less than 50 percent of all transactions costs in groundwater markets, it has a sizeable impact on irrigated area, especially for small farmers. Uncertainty coupled with land fragmentation also attenuates the benefits of the water-saving technologies now being heavily promoted in India.
    Keywords: Debt Markets,Water and Industry,Water Supply and Systems,Drought Management,Water Use
    Date: 2016–06–06
  5. By: Hurkens, Sjaak; Jeon, Doh-Shin; Menicucci, Domenico
    Abstract: We contribute to the leverage theory of tying by studying bundling of a dominant firm instead of a monopolist. We show that, when one firm has symmetric dominance across all markets, bundling has a positive demand size effect on the dominant firm but affects both firms similarly through the demand elasticity effect. The demand size affect is hump-shaped in dominance level whereas the demand elasticity affect is increasing and negative (positive) for low (high) dominance levels. This makes bundling credible for sufficiently strong dominance. In the case of asymmetric dominance levels, we identify three different circumstances in which a firm can credibly leverage its dominance in some (tying) markets to foreclose a dominant rival in other (tied) markets. Our findings provide a justification for the use of contractual bundling for foreclosure.
    Keywords: Bundling; Dominance; Entry Barrier; leverage; Tying
    JEL: D43 L13 L41
    Date: 2016–05
  6. By: Eduardo Engel; Ronald Fischer; Alexander Galetovic
    Abstract: We examine optimal contracts for PPPs which receive revenue from user fees as well as ancillary commercial revenue, for example from commercial space in the case of airports. We assume that demand for the project is exogenous. Ancillary revenue is observable and requires effort by the concessionaire. If this additional revenue is proportional to demand for the underlying PPP project, we show that the optimal contract of the concessionaire eliminates all exogenous risk but retains a fraction of the endogenous risk. The contract can be implemented via a standard Present-Value-of-Revenue (PVR) auction (Engel et al., 2001). JEL classiffications: H440, R420, L51 Key words: Creation-Date: 2015

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