nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2020‒03‒23
four papers chosen by
Guillem Roig
University of Melbourne

  1. Mechanism Design with Blockchain Enforcement By Hitoshi Matsushima; Shunya Noda
  2. Efficiency Versus Equity in the Provision of In-Kind Benefits: Evidence from Cost Containment in the California WIC Program By Meckel, Katherine; Rossin-Slater, Maya; Uniat, Lindsey
  3. A Climate Insidium with a Price on Warming By John F. Raffensperger
  4. Pricing Interest Rate Derivatives under Volatility Uncertainty By Julian H\"olzermann

  1. By: Hitoshi Matsushima (Department of Economics, University of Tokyo); Shunya Noda (Vancouver School of Economics, University of British Columbia)
    Abstract: We study the design of self-enforcing mechanisms that rely on neither a trusted third party (e.g., court, trusted mechanism designer) nor a long-term relationship. Instead, we use a smart contract written on blockchains as a commitment device. We design the digital court, a smart contract that identifies and punishes agents who reneged on the agreement. The digital court substitutes the role of legal enforcement in the traditional mechanism design paradigm. We show that, any agreement that is implementable with legal enforcement can also be implemented with enforcement by the digital court. To pursue a desirable design of the digital court, we study a way to leverage truthful reports made by a small fraction of behavioral agents. Our digital court has a unique equilibrium as long as there is a positive fraction of behavioral agents, and it gives correct judgment in the equilibrium if honest agents are more likely to exist than dishonest agents. The platform for smart contracts is already ready in 2020; thus, self-enforcing mechanisms proposed in this paper can be used practically, even now. As our digital court can be used for implementing general agreements, it does not leak the detailed information about the agreement even if it is deployed on a public blockchain (e.g., Ethereum) as a smart contract.
    Keywords: Implementation, Decentralized Mechanism, Smart Contract, Oracle Problem, Self-Judgment
    JEL: D47 D82 L86
    Date: 2020–03
  2. By: Meckel, Katherine (University of California, San Diego); Rossin-Slater, Maya (Stanford University); Uniat, Lindsey (Yale University)
    Abstract: The government often contracts with private firms to deliver in-kind safety net benefits. These public-private partnerships generate agency problems that could increase costs, but cost-containment reforms may discourage firm participation. We study a 2012 reform of California's Special Supplemental Nutrition Program for Women, Infants, and Children that reduced the number of small vendors. We show that within-ZIP-code access to small vendors increases take-up among first-time and foreign-born mothers, suggesting that small vendors are distinctly effective at lowering take-up barriers among women with high program learning costs. Thus, cost containment reforms may have unintended consequences of inequitably reducing program access.
    Keywords: WIC program, benefit take-up, in-kind transfers, cost containment
    JEL: H40 I18 I38
    Date: 2020–02
  3. By: John F. Raffensperger
    Abstract: In this paper, I introduce a new emissions trading system (ETS) design to address the problems with existing ETSs and carbon taxes. First, existing ETS designs inhibit emissions but do not constrain warming to any set level. Existing ETSs have the indirect objective of reducing emissions instead of directly reducing warming. Even a global mechanism using an existing ETS cannot guarantee a particular warming path. Part 1: A Price on Warming addresses this. My proposed market trades contracts tied to temperature in a double-sided auction of emissions permits and sequestration contracts. Unlike existing ETSs, the mechanism has a consistent timescale and metric tied to warming, with explicit limits on global temperature in every period into the far future. Every auction finds prices for emissions into the far future. Second, if a jurisdiction does not require firms to manage their emissions, the firms have little incentive to do so. Part 2: A Climate Insidium addresses this. My design incentivizes firms to participate even if their jurisdictions do not join. With sanctions from member jurisdictions and participating firms, the design has bottom-up incentives for joining, and the incentives rise over time under realistic conditions, potentially resulting in a rush to join. Third, existing designs have high transaction costs for implementation, requiring international treaties to begin. Part 3: A Faster Path Forward addresses this. I propose a path without national or international action to begin. A coalition can implement these rules, creating political force to accelerate participation. Full implementation still requires national agreements. This design appears to be closer to "first best", with a lower cost of climate mitigation, than any in the literature, while increasing the certainty of avoiding catastrophic global warming. It might also provide a faster pathway to implementation.
    Date: 2020–03
  4. By: Julian H\"olzermann
    Abstract: We study the pricing of contracts in fixed income markets in the presence of volatility uncertainty. We consider an arbitrage-free bond market under volatility uncertainty. The uncertainty about the volatility is modeled by a G-Brownian motion, which drives the forward rate dynamics. The absence of arbitrage is ensured by a drift condition. In such a setting we obtain a sublinear pricing measure for additional contracts. Similar to the forward measure approach, we define a forward sublinear expectation to simplify the valuation of cashflows. Under the forward sublinear expectation, we obtain a robust version of the expectations hypothesis and a valuation method for bond options. With these tools, we derive robust pricing rules for the most common interest rate derivatives: fixed coupon bonds, floating rate notes, interest rate swaps, swaptions, caps, and floors. For fixed coupon bonds, floating rate notes, and interest rate swaps, we obtain a single price, which is the same as in traditional models. For swaptions, caps, and floors, we obtain a range of prices, which is bounded by the prices from traditional models with the highest and lowest possible volatility. Due to these pricing formulas, the model naturally exhibits unspanned stochastic volatility.
    Date: 2020–03

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