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Disagreement and learning in a dynamic contracting model

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Tobias Adrian
Mark M. Westerfield

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Abstract

The authors present a dynamic contracting model in which the principal and the agent disagree about the resolution of uncertainty, and they illustrate the contract design in an application with Bayesian learning. The disagreement creates gains from trade that the principal realizes by transferring payment to states that the agent considers relatively more likely, a shift that changes incentives. In their dynamic setting, the interaction between incentive provision and learning creates an intertemporal source of “disagreement risk” that alters optimal risk sharing. An endogenous regime shift between economies with small and large belief differences is present, and an early shock to beliefs can lead to large persistent differences in variable pay even after beliefs have converged. Under risk-neutrality, “selling the firm” to the agent does not implement the first-best outcome because it precludes state-contingent trades.

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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 269.

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Date of creation: 2008
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Handle: RePEc:fip:fednsr:269

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Related research
Keywords: Contracts ; Uncertainty ; Econometric models ; Microeconomics;

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  3. Roland Bénabou & Jean Tirole, 2002. "Self-Confidence And Personal Motivation," The Quarterly Journal of Economics, MIT Press, vol. 117(3), pages 871-915, August. [Downloadable!] (restricted)
  4. Takatoshi Ito, 1990. "Foreign Exchange Rate Expectations: Micro Survey Data," NBER Working Papers 2679, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. Milgrom, Paul & Stokey, Nancy, 1982. "Information, trade and common knowledge," Journal of Economic Theory, Elsevier, vol. 26(1), pages 17-27, February. [Downloadable!] (restricted)
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  6. Muhamet Yildiz, 2003. "Bargaining without a Common Prior-An Immediate Agreement Theorem," Econometrica, Econometric Society, vol. 71(3), pages 793-811, 05. [Downloadable!] (restricted)
  7. Ross, Stephen A, 1973. "The Economic Theory of Agency: The Principal's Problem," American Economic Review, American Economic Association, vol. 63(2), pages 134-39, May. [Downloadable!] (restricted)
  8. Noah Williams, 2004. "On Dynamic Principal-Agent Problems in Continuous Time," Levine's Bibliography 122247000000000426, UCLA Department of Economics. [Downloadable!]
  9. Terrance Odean, 1999. "Do Investors Trade Too Much?," American Economic Review, American Economic Association, vol. 89(5), pages 1279-1298, December. [Downloadable!] (restricted)
  10. Bengt Holmstrom, 1979. "Moral Hazard and Observability," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 74-91, Spring. [Downloadable!] (restricted)
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  1. Rajiv Sethi & Muhamet Yildiz, 2009. "Public Disagreement," Economics Working Papers 0089, Institute for Advanced Study, School of Social Science. [Downloadable!]
  2. Leonidas Enrique De La Rosa, 2008. "Overconfidence in a Career-Concerns Setting," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
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