We propose a model of financial intermediation based on delegated monitoring, where firms' returns are private information that lenders can ascertain through costly state verification. Our model has two key features: lenders cannot commit to their verification strategies and there are aggregate shocks. Simple debt contracts are Pareto optimal with or without intermediation. We show that the benefits of intermediation can be limited by financial instability in the presence of aggregate shocks. However, a well-designed resolution mechanism ensures the Pareto optimality of financial intermediation, and a bail-out policy can restore financial stability.
This paper makes two fundamental contributions: (i) We prove that the interior Ramsey steady state commonly assumed in the literature may not exist in a standard Aiyagari model—in particular, a steady state with the modified golden rule and a positive capital tax is shown to be feasible but not optimal under conventional parameter values for the intertemporal elasticity of substitution. (ii) We design a modified, analytically tractable version of the standard Aiyagari model to reveal the necessary and/or sufficient conditions for the existence of a Ramsey steady state. We characterize the basic properties of both interior and non-interior Ramsey steady states and show that researchers may draw fundamentally misleading conclusions about optimal fiscal policy (such as the optimal capital tax rate) from their analysis if an interior Ramsey steady state is incorrectly assumed.
We introduce a learning model in which the decision maker does not know how recommendations are generated, called the contraction rule. We present behavioral postulates that characterize it. The contraction rule can be uniquely identified and reveals how the decision maker interprets and how much she trusts the recommendation. In a dynamic stationary setting, we show that the contraction rule is not dominated by completely following recommendations and is incompatible with a property called compliance with balanced recommendations. Following this negative result, we demonstrate that the contraction rule may generate and reinforce recency bias and disagreement.
We offer a model of scientific progress in which uncertainty resolves over time. We show that rivalry leads to less experimentation, extending results for preemption games to experimentation with uncertain outcomes. We compare experimentation duration and welfare when experimental outcomes are publicly versus privately observable. We show that public learning can generate more experimentation and higher welfare when uncertainty about the feasibility of a breakthrough is large; breakthroughs are rare even when they are feasible; and experiments produce results infrequently. Our results shed light on recent criticism of the science system.
Economic agents are motivated to undertake costly actions by the prospect of being rewarded for successes and punished for failures. But what determines what a success looks like? This paper endogenizes the criteria for success in an otherwise standard principal-agent model with risk neutrality and limited liability. The set of feasible contracts is constrained by incentive constraints and possibly by a budget constraint. The first-order approach is not required to solve the problem. If the principal manipulates the criteria for success only to lower implementation costs, and depending on which type of constraint is more restrictive, the second-best action may be above or below the first-best action. In a class of problems where the principal's payoff depends directly on the criteria for success, the second-best solution features either more stringent criteria for success or a lower action (or both) than the first-best solution.
Safe asset demand increases loan risk. This arises in a competitive model in which securitization vehicles create safe assets by pooling loan payoffs purchased from loan originators. Equity investors allocate their wealth between originators, who need skin-in-the-game due to moral hazard, and vehicles, who need loss-absorption capacity against aggregate risk. An increase in demand for safety fosters safe asset creation through a securitization boom: originators sell more of their loan payoffs to vehicles, equity is reallocated from originators to vehicles, and the two effects contribute to an increase in loan risk. The model is consistent with a broad set of facts in the run-up to the Global Financial Crisis.
We study the random assignment of indivisible objects among a set of agents with strict preferences. We show that there exists no mechanism which is unanimous, strategy-proof and envy-free. Weakening the first requirement to q-unanimity – i.e., when every agent ranks a different object at the top, then each agent shall receive his most-preferred object with probability of at least q – we show that a mechanism satisfying strategy-proofness, envy-freeness and ex-post weak non-wastefulness can be q-unanimous only for q≤2n (where n is the number of agents). To demonstrate that this bound is tight, we introduce a new mechanism, Random-Dictatorship-cum-Equal-Division (RDcED), and show that it achieves this maximal bound when all objects are acceptable. In addition, for three agents, RDcED is characterized by the first three properties and ex-post weak efficiency. If objects may be unacceptable, strategy-proofness and envy-freeness are jointly incompatible even with ex-post weak non-wastefulness.
We investigate implementation under incomplete information allowing for individuals' choices featuring violations of rationality. Our primitives are individuals' interim choices that do not have to satisfy the weak axiom of revealed preferences. In this setting, we provide necessary as well as sufficient conditions for behavioral implementation under incomplete information. We also introduce behavioral interim incentive Pareto efficiency and investigate its implementability under incomplete information.
We consider the design of contests when the principal can choose both the prize profile and how the prizes are allocated as a function of a possibly noisy signal about the agents' efforts. We provide sufficient conditions that guarantee optimality of a contest. Optimal contests have a minimally competitive prize profile and an intermediate degree of competitiveness in the contest success function. Whenever observation is not too noisy, the optimum can be achieved by an all-pay contest with a cap. When observation is perfect, the optimum can also be achieved by a nested Tullock contest. We relate our results to a recent literature which has asked similar questions but has typically focused on the design of either the prize profile or the contest success function.
Bayesian analysis is considered the optimal way of processing information. However, it often leads to problems for decision-makers with constrained cognitive capacity. Modeling such constrained capacity by finite automata, we answer two questions in the context of Wald's (1947) sequential analysis, namely in what environments is optimal Bayesian analysis possible even with constraints; also, when it is not possible what simplifications in the analysis enable us to obtain a satisfactory outcome. We identify two features of the simplified analysis: information stickiness (ignoring information) and rule stickiness (ignoring small differences in the environment).
The dwindling popularity of globalization and international cooperation poses the issue of exiting an international union. An individually made exit decision is inefficient, as it neglects the losses of the other members. Fiscal transfers inside the union eliminate socially inefficient exits and restore the first-best outcome. When fiscal transfers are impossible, the union benefits from introducing exit costs during the formation process. Those costs are Pareto-optimal despite being a deadweight loss. If the union cannot fully commit to imposing exit costs ex post, it can use the anticipation of further exit decisions to increase its credibility. The paper also explores the scope for post-exit cooperation between the exiting country and the union. I show that both parties prefer a soft exit over a no-deal exit. However, the union might be reluctant to agree to a deal if it forms a precedent for the other union members. The model sheds light on Brexit and the UK-EU negotiations but also applies to other international unions.
The standard Subjective Expected Utility model of decision-making implies that information can never have a negative value ex-ante. Many ambiguity theories have since questioned this property. We provide an experimental test of the connection between the value of information and ambiguity attitude. Our results show that the value of information can indeed be negative when new information renders hedging against ambiguity impossible. Moreover, the value of information is correlated with ambiguity aversion. This confirms the predictions from ambiguity theories and may have implications for decision-making in uncertain and dynamic environments. Neither complexity avoidance nor information with ambiguous reliability can reproduce the results.
Fiscal-backed money can provide additional liquidity to consumers and mitigate the liquidity shortage problem in an economy with banks where agents face idiosyncratic liquidity shocks without being fully insured. The government issues fiat money and creates real value for money by levying a tax and accepting money for tax payments. Tax reallocates the distribution of liquidity in the economy. An increase in tax, by increasing fiscal surplus and the real value of money, reduces the equilibrium investment. Additionally, imposing taxes influences the incentive of private information production, which may impose a constraint on optimal fiscal policy.
Is growth ultimately fully endogenous or semi-endogenous? Three decades of theoretical and empirical growth economics have kept both possibilities open. Here, R&D-driven growth is a general combination of both semi-endogenous and fully endogenous mechanisms.I demonstrate that if the semi-endogenous growth component is indispensable to the actual growth mechanism, the long-run growth rate follows the semi-endogenous growth predictions. Conversely, if the semi-endogenous growth is non-essential and the world population experiences slow growth, the fully en-dogenous growth mechanism could dictate the long run, even if it is not essential.If no other (third) growth mechanism exists, a criterion sufficient to ascertain the essentiality of semi -endogenous growth is that reduced research consistently leads to fewer innovations.If an unknown third growth engine exists, the steady state remains semi-endogenous, provided the essentiality criterion is met. Regardless of how this third factor impacts short-term growth, semi-endogenous growth will prevail in the long run.(c) 2023 The Author(s). Published by Elsevier Inc. This is an open access article under the CC BY license (http://creativecommons .org /licenses /by /4 .0/).
I study a Bayesian persuasion model in which multiple senders sequentially persuade one receiver, after observing signal structures of prior senders and their realizations. I develop a geometric method, recursive concavification, to characterize the Perfect Bayesian Equilibrium paths. I prove the existence of the silent equilibrium, where at most one sender provides nontrivial information. I also show that when there are only two senders and the receiver has a finite action space, it is generically without loss to focus on silent equilibrium. Finally, I show that if there are two senders who have zero-sum payoffs, the truth-telling signal structure is always supported in equilibrium.
We study signaling games with quadratic payoffs. As signaling games admit multiple separating equilibria, many equilibrium selection rules are proposed and a well-known solution is Riley equilibria. They are separating equilibria in which the sender achieves the highest equilibrium payoff for all types among all separating equilibria. We analyze the conditions for Riley equilibria to be linear, a common assumption in many applications. We derive a sufficient and necessary condition for the existence and uniqueness of linear Riley equilibria. We apply the result to confirm the dominance of linear equilibria in some classic examples, and we show that, in some other examples, there exist previously unknown nonlinear Riley equilibria.
I analyze a novel spillover effect from collateralized to uncollateralized loans. High-type borrowers have good projects, while low-type borrowers do not know their project quality. High-type borrowers post collateral, and a monopolist bank screens only low-type borrowers ' projects. Different from existing models, equilibrium collateral requirements are stricter than the minimum necessary to achieve separation, even if collateral is costly. When high-type borrowers post more collateral, the bank charges a higher interest rate to low-type borrowers. This, in turn, enhances the bank's incentives to screen the low-types ' projects, thereby improving the average quality of uncollateralized loans. (c) 2023 The Author(s). Published by Elsevier Inc. This is an open access article under the CC BY license (http://creativecommons.org/licenses/by/4.0/).
We provide a test of the axioms of certainty and weak certainty independence in models of decision-making under subjective uncertainty. We show that it is through these two weakenings of the classic independence axiom that prominent ambiguity models retain properties that stand in conflict with the ambiguity-sensitive behavior that is revealed in our experiment. Our findings suggest that this conflict may be of a more fundamental nature than what most of these models can accommodate. Our results call for the use of ambiguity models that can accommodate an ambiguity attitude which depends on the chances of winning.
We offer an approach to cooperation in repeated games of private monitoring in which players construct models of their opponents' behavior by observing the frequencies of play in a record of past plays of the game in which actions but not signals are recorded. Players construct models of their opponent's behavior by grouping the histories in the record into a relatively small number of analogy classes for which they estimate probabilities of cooperation. The incomplete record and the limited number of analogy classes lead to misspecified models that provide the incentives to cooperate. We provide conditions for the existence of equilibria supporting cooperation and equilibria supporting high payoffs for some nontrivial analogy partitions.
