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Efficient Allocations in Dynamic Private Information Economies with Persistent Shocks: A First-Order Approach

  • Marek Kapicka

This article studies efficient allocations in a dynamic private information economy with a continuum of idiosyncratic shocks that are persistent. I develop a first-order approach for this environment and show that the problem has a simple recursive structure that relies on only a small number of state variables, making the problem tractable. I find sufficient conditions that guarantee that the first-order approach is valid. To illustrate the first-order approach I numerically compute the efficient allocations in a Mirrleesean economy with productivity shocks that follow a random walk and verify the validity of the first-order approach. I show that persistent shocks create a new trade-off where the social planner decreases the informational rent of the agent today at the cost of providing higher insurance in the future. Copyright 2013, Oxford University Press.

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File URL: http://hdl.handle.net/10.1093/restud/rds045
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Article provided by Oxford University Press in its journal Review of Economic Studies.

Volume (Year): 80 (2013)
Issue (Month): 3 ()
Pages: 1027-1054

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Handle: RePEc:oup:restud:v:80:y:2013:i:3:p:1027-1054
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