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Recursive Contracts, Lotteries and Weakly Concave Pareto Sets

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  • Harold Cole

    (University of Pennsylvania)

  • Felix Kubler

    (University of Mannheim)

Abstract

Marcet and Marimon (1994, revised 1998, revised 2011) developed a recursive saddle point method which can be used to solve dynamic contracting problems that include participation, enforcement and incentive constraints. Their method uses a recursive multiplier to capture implicit prior promises to the agent(s) that were made in order to satisfy earlier instances of these constraints. As a result, their method relies on the invertibility of the derivative of the Pareto frontier and cannot be applied to problems for which this frontier is not strictly concave. In this paper we show how one can extend their method to a weakly concave Pareto frontier by expanding the state space to include the realizations of an end of period lottery over the extreme points of a flat region of the Pareto frontier. With this expansion the basic insight of Marcet and Marimon goes through -- one can make the problem recursive in the Lagrangian multiplier which yields significant computational advantages over the conventional approach of using utility as the state variable. The case of a weakly concave Pareto frontier arises naturally in applications where the principal's choice set is not convex but where randomization is possible. (Copyright: Elsevier)

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Bibliographic Info

Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 15 (2012)
Issue (Month): 4 (October)
Pages: 479-500

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Handle: RePEc:red:issued:11-266

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Keywords: Recursive contracting; recursive multipliers; lotteries;

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References

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Cited by:
  1. Matthias Messner & Nicola Pavoni & Christopher Sleet, 2012. "Recursive Methods for Incentive Problems," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 15(4), pages 501-525, October.
  2. Messner Matthias & Pavoni Nicola & Sleet Christopher, . "Recursive Methods for Dynamic Incentive Problems," GSIA Working Papers, Carnegie Mellon University, Tepper School of Business 2012-E13, Carnegie Mellon University, Tepper School of Business.
  3. Matthias Messner & Nicola Pavoni & Christopher Sleet, 2012. "Contractive Dual Methods for Incentive Problems," Working Papers, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University 466, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  4. Chien, YiLi & Cole, Harold L. & Lustig, Hanno, 2014. "Implications of heterogeneity in preferences, beliefs and asset trading technologies for the macroeconomy," Working Papers, Federal Reserve Bank of St. Louis 2014-14, Federal Reserve Bank of St. Louis.
  5. Mele, Antonio, 2014. "Repeated moral hazard and recursive Lagrangeans," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 42(C), pages 69-85.
  6. Matthias Messner & Nicola Pavoni & Christopher Sleet, 2011. "On the Dual Approach to Recursive Optimization," Working Papers, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University 423, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  7. Albert Marcet & Ramon Marimon, 2011. "Recursive Contracts," Working Papers 552, Barcelona Graduate School of Economics.

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