nep-cta New Economics Papers
on Contract Theory and Applications
Issue of 2021‒11‒22
five papers chosen by
Guillem Roig
University of Melbourne

  1. Moral Hazard, Dynamic Incentives, and Ambiguous Perceptions By Martin Dumav
  2. Reference Points and the Tradeoff between Risk and Incentives By Dohmen, Thomas; Non, Arjan; Stolp, Tom
  3. Optimal State Contingent Sovereign Debt Instruments By Mr. Alejandro D Guerson
  4. Negotiating Networks in Oligopoly Markets for Price-Sensitive Products By Naman Shukla; Kartik Yellepeddi
  5. Rational play in games: A behavioral approach By Giacomo Bonanno

  1. By: Martin Dumav
    Abstract: This paper considers dynamic moral hazard settings, in which the consequences of the agent's actions are not precisely understood. In a new continuous-time moral hazard model with drift ambiguity, the agent's unobservable action translates to drift set that describe the evolution of output. The agent and the principal have imprecise information about the technology, and both seek robust performance from a contract in relation to their respective worst-case scenarios. We show that the optimal long-term contract aligns the parties' pessimistic expectations and broadly features compressing of the high-powered incentives. Methodologically, we provide a tractable way to formulate and characterize optimal long-run contracts with drift ambiguity. Substantively, our results provide some insights into the formal link between robustness and simplicity of dynamic contracts, in particular high-powered incentives become less effective in the presence of ambiguity.
    Date: 2021–10
  2. By: Dohmen, Thomas (University of Bonn and IZA); Non, Arjan (Erasmus University Rotterdam); Stolp, Tom (SEO Amsterdam)
    Abstract: We conduct laboratory experiments to investigate basic predictions of principal-agent theory about the choice of piece rate contracts in the presence of output risk, and provide novel insights that reference dependent preferences affect the tradeoff between risk and incentives. Subjects in our experiments choose their compensation for performing a real-effort task from a menu of linear piece rate and fixed payment combinations. As classical principal-agent models predict, more risk averse individuals choose lower piece rates. However, in contrast to those predictions, we find that low-productivity risk averse workers choose higher piece rates when the riskiness of the environment increases. We hypothesize that reference points affect piece rate choice in risky environments, such that individuals whose expected earnings would exceed (fall below) the reference point in a risk-free environment behave risk averse (seeking) in risky environments. In a second experiment, we exogenously manipulate reference points and confirm this hypothesis.
    Keywords: incentive, piece-rate, risk, reference point, laboratory experiment
    JEL: D81 D91 M52
    Date: 2021–11
  3. By: Mr. Alejandro D Guerson
    Abstract: This paper shows that the optimal sovereign lending contract is state-contingent when a government can default. It provides a theoretical basis for the specification of optimal state-contingent debt instruments (SCDIs) in countries subject to large shocks that can be observed and verified by all parties involved, such as natural disasters or global pandemics. The result is obtained as the endogenous solution to a contracting problem under time-inconsistency when a government cannot credibly commit to honor debt service obligations in all possible states of nature. It is shown that rational investors optimally offer SCDIs that include additional financing when the default constraint is binding, keeping the debtor engaged in the contractual relationship and avoiding asset loss. The debtor benefits because the contract implies net-positive financing when facing a large shock, increasing concurrent welfare, while maintaining access to financing in the future for consumption smoothing at the same terms as with precommitment. SCDIs require maintaining debt at a low level compared to the precommitment case, and also a fiscal consolidation when triggered to contain the increase in debt. Extension of the time inconsistency problem to add the taxation of capital returns shows that the optimal physical capital investment is also state-contingent.
    Keywords: sovereign default; natural disasters; state-contingent debt
    Date: 2021–09–10
  4. By: Naman Shukla; Kartik Yellepeddi
    Abstract: We present a novel framework to learn functions that estimate decisions of sellers and buyers simultaneously in an oligopoly market for a price-sensitive product. In this setting, the aim of the seller network is to come up with a price for a given context such that the expected revenue is maximized by considering the buyer's satisfaction as well. On the other hand, the aim of the buyer network is to assign probability of purchase to the offered price to mimic the real world buyers' responses while also showing price sensitivity through its action. In other words, rejecting the unnecessarily high priced products. Similar to generative adversarial networks, this framework corresponds to a minimax two-player game. In our experiments with simulated and real-world transaction data, we compared our framework with the baseline model and demonstrated its potential through proposed evaluation metrics.
    Date: 2021–10
  5. By: Giacomo Bonanno (Department of Economics, University of California Davis)
    Abstract: We argue in favor of a departure from the standard equilibrium approach in game theory in favor of the less ambitious goal of describing only the actual behavior of rational players. We investigate the notion of rationality in behavioral models of extensive-form games (allowing for imperfect information), where a state is described in terms of a play of the game instead of a strategy profile. The players' beliefs are specified only at reached decision histories and are modeled as pre-choice beliefs, allowing us to carry out the analysis without the need for (objective or subjective) counterfactuals. The analysis is close in spirit to the literature on self-confirming equilibrium, but it does not rely on the notion of strategy. We also provide a characterization of rational play that is compatible with pure-strategy Nash equilibrium.
    Keywords: Rationality, extensive-form game, self-confirming equilibrium, Nash equilibrium, behavioral model
    JEL: C7
    Date: 2021–11–17

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