Creator: Blandin, Adam, Boyd, John H., and Prescott, Edward C. Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 717 Abstract:
We develop an equilibrium concept in the Debreu (1954) theory of value tradition for a class of adverse selection economies which includes the Spence (1973) signaling and Rothschild-Stiglitz (1976) insurance environments. The equilibrium exists and is optimal. Further, all equilibria have the same individual type utility vector. The economies are large with a finite number of types that maximize expected utility on an underlying commodity space. An implication of the analysis is that the invisible hand works for this class of adverse selection economies.
Keyword: Insurance, Mutual organization, Adverse selection equilibrium, Theory of value, The core, and Signaling Subject (JEL): G22 - Insurance; Insurance Companies; Actuarial Studies, C62 - Existence and Stability Conditions of Equilibrium, G29 - Financial Institutions and Services: Other, D46 - Value Theory, and D82 - Asymmetric and Private Information; Mechanism Design
Creator: Atkeson, Andrew, Hellwig, Christian, and Ordonez, Guillermo Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 464 Abstract:
In all markets, firms go through a process of creative destruction: entry, random growth and exit. In many of these markets there are also regulations that restrict entry, possibly distorting this process. We study the public interest rationale for entry taxes in a general equilibrium model with free entry and exit of firms in which firm dynamics are driven by reputation concerns. In our model firms can produce high-quality output by making a costly but efficient initial unobservable investment. If buyers never learn about this investment, an extreme “lemons problem” develops, no firm invests, and the market shuts down. Learning introduces reputation incentives such that a fraction of entrants do invest. We show that, if the market operates with spot prices, entry taxes always enhance the role of reputation to induce investment, improving welfare despite the impact of these taxes on equilibrium prices and total production.
Keyword: Entry and exit, Creative destruction, Firm dynamics, General equilibrium, Regulation, and Reputation Subject (JEL): D21 - Firm Behavior: Theory, L15 - Information and Product Quality; Standardization and Compatibility, L51 - Economics of Regulation, and D82 - Asymmetric and Private Information; Mechanism Design
Creator: Ordonez, Guillermo Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 431 Abstract:
Concerns about constructing and maintaining good reputations are known to reduce borrowers’ excessive risk-taking. However, I find that the self-discipline induced by these concerns is fragile, and can break down without obvious changes in economic fundamentals. Furthermore, in the aggregate, breakdowns are clustered among borrowers with intermediate and good reputations, which can exacerbate an economy’s weakness and contribute to a broad economic crisis. These results come from an aggregate dynamic global game analysis of reputation formation in credit markets. The selection of a unique equilibrium is accomplished by assuming that borrowers have incomplete information about economic fundamentals.
Keyword: Fragility, Reputation, Risk-taking, and Global games Subject (JEL): E44 - Financial Markets and the Macroeconomy, D82 - Asymmetric and Private Information; Mechanism Design, G32 - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill, and G01 - Financial Crises
Creator: Chari, V. V., Golosov, Mikhail, and Tsyvinski, Aleh Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 673 Abstract:
Innovative activities have public good characteristics in the sense that the cost of producing the innovation is high compared to the cost of producing subsequent units. Moreover, knowledge of how to produce subsequent units is widely known once the innovation has occurred and is, therefore, non-rivalrous. The main question of this paper is whether mechanisms can be found which exploit market information to provide appropriate incentives for innovation. The ability of the mechanism designer to exploit such information depends crucially on the ability of the innovator to manipulate market signals. We show that if the innovator cannot manipulate market signals, then the efficient levels of innovation can be implemented without deadweight losses–for example, by using appropriately designed prizes. If the innovator can use bribes, buybacks, or other ways of manipulating market signals, patents are necessary.
Keyword: Innovations, Mechanism design, Patents, Prizes, and Economic growth Subject (JEL): O31 - Innovation and Invention: Processes and Incentives, D86 - Economics of Contract: Theory, O34 - Intellectual Property and Intellectual Capital, D82 - Asymmetric and Private Information; Mechanism Design, O40 - Economic Growth and Aggregate Productivity: General, and D04 - Microeconomic Policy: Formulation, Implementation, and Evaluation
Creator: Ales, Laurence and Maziero, Pricila Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 663 Abstract:
We study the quantitative properties of constrained efficient allocations in an environment where risk sharing is limited by the presence of private information. We consider a life cycle version of a standard Mirrlees economy where shocks to labor productivity have a component that is public information and one that is private information. The presence of private shocks has important implications for the age profiles of consumption and income. First, they introduce an endogenous dispersion of continuation utilities. As a result, consumption inequality rises with age even if the variance of the shocks does not. Second, they introduce an endogenous rise of the distortion on the marginal rate of substitution between consumption and leisure over the life cycle. This is because, as agents age, the ability to properly provide incentives for work must become less and less tied to promises of benefits (through either increased leisure or consumption) in future periods. Both of these features are also present in the data. We look at the data through the lens of our model and estimate the fraction of labor productivity that is private information. We find that for the model and data to be consistent, a large fraction of shocks to labor productivities must be private information.
Keyword: Risk sharing, Private information, and Consumption inequality Subject (JEL): D91 - Micro-Based Behavioral Economics: Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making, H21 - Taxation and Subsidies: Efficiency; Optimal Taxation, D11 - Consumer Economics: Theory, D58 - Computable and Other Applied General Equilibrium Models, D86 - Economics of Contract: Theory, and D82 - Asymmetric and Private Information; Mechanism Design
Creator: Zhang, Yuzhe Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 640 Abstract:
In this paper I develop continuous-time methods for solving dynamic principal-agent problems in which the agent’s privately observed productivity shocks are persistent over time. I characterize the optimal contract as the solution to a system of ordinary differential equations, and show that, under this contract, the agent’s utility converges to its lower bound—immiseration occurs. I also show that, unlike in environments with i.i.d. shocks, the principal would like to renegotiate with the agent when the agent’s productivity is low—it is not renegotiation-proof. I apply the theoretical methods I have developed and numerically solve this (Mirrleesian) dynamic taxation model. I find that it is optimal to allow a wedge between the marginal rate of transformation and individuals’ marginal rate of substitution between consumption and leisure. This wedge is significantly higher than what is found in the i.i.d. case. Thus, using the i.i.d. assumption is not a good approximation quantitatively when there is persistence in productivity shocks.
Keyword: Principal-agent problem, Persistence, Efficiency lines, and Stochastic control problem Subject (JEL): E61 - Policy Objectives; Policy Designs and Consistency; Policy Coordination, D80 - Information, Knowledge, and Uncertainty: General, and D82 - Asymmetric and Private Information; Mechanism Design
Creator: Hopenhayn, Hugo Andres, Llobet, Gerard, and Mitchell, Matt Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 273 Abstract:
This paper presents a model of cumulative innovation where firms are heterogeneous in their research ability. We study the optimal reward policy when the quality of the ideas and their subsequent development effort are private information. The optimal assignment of property rights must counterbalance the incentives of current and future innovators. The resulting mechanism resembles a menu of patents that have infinite duration and fixed scope, where the latter increases in the value of the idea. Finally, we provide a way to implement this patent menu by using a simple buyout scheme: The innovator commits at the outset to a price ceiling at which he will sell his rights to a future inventor. By paying a larger fee initially, a higher price ceiling is obtained. Any subsequent innovator must pay this price and purchase its own buyout fee contract.
Keyword: Compulsory Licensing, Innovation, Patents, Policy, Mechanism Design, Asymmetric Information, and Sequential Innovation Subject (JEL): L50 - Regulation and Industrial Policy: General, K23 - Regulated Industries and Administrative Law, L51 - Economics of Regulation, D82 - Asymmetric and Private Information; Mechanism Design, D43 - Market Structure, Pricing, and Design: Oligopoly and Other Forms of Market Imperfection, H41 - Public Goods, and O31 - Innovation and Invention: Processes and Incentives
Creator: Katzman, Brett, 1966-, Kennan, John, and Wallace, Neil Series: Working paper (Federal Reserve Bank of Minneapolis. Research Department) Number: 595 Abstract:
The effects on ex ante optima of a lag in seeing monetary realizations are studied using a matching model of money. The main new ingredient in the model is meetings in which producers have more information than consumers. A consequence is that increases in the amount of money that occur with small enough probability can have negative impact effects on output, because it is optimal to shut down trade in such low probability meetings rather than have lower output when high probability realizations occur. The information lag also produces prices that do not respond much to current monetary realizations.
Subject (JEL): E30 - Prices, Business Fluctuations, and Cycles: General (includes Measurement and Data), E40 - Money and Interest Rates: General, and D82 - Asymmetric and Private Information; Mechanism Design
Creator: Fernandes, Ana and Phelan, Christopher Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 259 Abstract:
There is now an extensive literature regarding the efficient design of incentive mechanisms in dynamic environments. In this literature, there are no exogenous links across time periods because either privately observed shocks are assumed time independent or past private actions have no influence on the realizations of current variables. The absence of exogenous links across time periods ensures that preferences over continuation contracts are common knowledge, making the definition of incentive compatible contracts at a point in time a simple matter. In this paper, we present general recursive methods to handle environments where privately observed variables are linked over time. We show that incentive compatible contracts are implemented recursively with a threat keeping constraint in addition to the usual temporary incentive compatibility conditions.
Keyword: Mechanism design and Repeated agency Subject (JEL): D31 - Personal Income, Wealth, and Their Distributions, D82 - Asymmetric and Private Information; Mechanism Design, D30 - Distribution: General, and D80 - Information, Knowledge, and Uncertainty: General
Creator: Allen, Beth Series: Staff report (Federal Reserve Bank of Minneapolis. Research Department) Number: 226 Abstract:
This paper surveys implementation theory when players have incomplete or asymmetric information, especially in economic environments. After the basic problem is introduced, the theory of implementation is summarized. Some coalitional considerations for implementation problems are discussed. For economies with asymmetric information, cooperative games based on incentive compatibility constraints or Bayesian incentive compatible mechanisms are derived and examined.
Keyword: Mechanisms, Incentive Compatibility, Bayesian-Nash Revelation Principle, Incomplete Information, Cooperative Games, Core, Implementation, Asymmetric Information, and Nontransferable Utility Subject (JEL): C72 - Noncooperative Games, D51 - Exchange and Production Economies, D82 - Asymmetric and Private Information; Mechanism Design, C71 - Cooperative Games, and D71 - Social Choice; Clubs; Committees; Associations