Holden, Helge () (Norwegian University of Science and Technology) Holden, Lars () (Norwegian Computing Center) Holden, Steinar () (Dept. of Economics, University of Oslo)
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Consider a contract between two players, describing the payment an agent obtains from the principal, in exchange for a good or service supplied. At each point in time, either player may unilaterally demand a renegotiation of the contract, involving renegotiation costs for both players. Players’ payoffs from trade under the contract, as well as from a renegotiated contract, are stochastic, following the exponential of a L´evy process. It is argued that the optimal strategy for each player is to require a renegotiation when the contract payment relative to the outcome of a renegotiation passes a certain threshold, depending on the stochastic processes, the discount rate, and the renegotiation costs. There is strategic substitutability in the choice of thresholds, so that if one player becomes more aggressive by choosing a threshold closer to unity, the other player becomes more passive. If players may invest in order to reduce the renegotiation costs, there will be over-investment compared to the welfare maximizing levels.
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Paper provided by Oslo University, Department of Economics in its series Memorandum with number
20/2004.
Find related papers by JEL classification: C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Danziger, Leif, 1983.
"Price Adjustments with Stochastic Inflation,"
International Economic Review,
Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 24(3), pages 699-707, October.
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