nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2016‒11‒20
three papers chosen by
Guillem Roig
University of Melbourne

  1. Loading Pricing of Catastrophe Bonds and Other Long-Dated, Insurance-Type Contracts By Eckhard Platen; David Taylor
  2. It’s a Sweetheart of a Deal: Political Connections and Federal Contracting By Stephen P. Ferris; Reza Houston
  3. Moral Hazard, Adverse Selection and Sharecropping in Ethiopia By Tran, Anh N.

  1. By: Eckhard Platen (Finance Discipline Group, UTS Business School, University of Technology, Sydney); David Taylor (Department of Actuarial Science and the African Collaboration for Quantitative Finance and Risk Research, University of Cape Town)
    Abstract: Catastrophe risk is a major threat faced by individuals, companies, and entire economies. Catastrophe (CAT) bonds have emerged as a method to offset this risk and a corresponding literature has developed that attempts to provide a market-consistent pricing methodology for these and other long-dated, insurance-type contracts. This paper aims to unify and generalize several of the widely-used pricing approaches for long-dated contracts with a focus on stylized CAT bonds and market-consistent valuation. It proposes a loading pricing concept that combines the theoretically possible minimal price of a contract with its formally obtained risk neutral price, without creating economically meaningful arbitrage. A loading degree controls how much influence the formally obtained risk neutral price has on the market price. A key finding is that this loading degree has to be constant for a minimally fluctuating contract, and is an important, measurable characteristic for prices of long-dated contracts. Loading pricing allows long-dated, insurance-type contracts to be priced less expensively and with higher return on investment than under classical pricing approaches. Loading pricing enables insurance companies to accumulate systematically reserves needed to manage its risk of ruin in a market consistent manner.
    Keywords: long-dated contracts; CAT bonds; real world pricing; risk neutral pricing; loading pricing; benchmark approach; market-consistent valuation
    JEL: G10 G13
    Date: 2016–10–01
  2. By: Stephen P. Ferris; Reza Houston
    Abstract: We examine whether political connections measured by political contributions influences the choice of terms included in government contracts awarded to firms. We construct an index of four “sweetheart” contract terms that are highly favorable to the firm, but not obviously advantageous to the government. We find that firms making larger political contributions more frequently have these terms included in their contracts. We then examine how changes in a firm’s political contributions influence the terms of subsequent contracts. We find that firms which increase their contributions are more likely to have these terms as part of their contract. We conclude that there is a political effect on the choice of terms included in federal contracts awarded to firms.
    Keywords: contracting; political connections
    JEL: G32 G38
    Date: 2016–09
  3. By: Tran, Anh N.
    Abstract: Sharecropping is commonly practised in developing countries but the debate over the existence and magnitude of its disincentive effects on productivity remains controversial under competing contracting models. We address the two issues by analysing the effects of sharecropping contracts on tenant's performance in two environments: selection bias into share tenancy due to cultivator heterogeneity and adverse selection from landowner side on land characteristics. Using longitudinal data collected for owner-cum-sharecroppers in Amhara, Ethiopia, controlling for the selection biases, we found significantly negative effects of sharecropping contracts on production outcomes and input provision. However, sharecropping inefficiency can be mitigated by cultivator-specific characteristics as household size, gender and productive assets, making policy suggestions on reducing market imperfections more relevant.
    Keywords: Crop Production/Industries, Farm Management, Risk and Uncertainty,

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