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Recursive Contracts and Endogenously Incomplete Markets

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  • Golosov, M.
  • Tsyvinski, A.
  • Werquin, N.

Abstract

In this chapter we study dynamic incentive models in which risk sharing is endogenously limited by the presence of informational or enforcement frictions. We comprehensively overview one of the most important tools for the analysis such problems—the theory of recursive contracts. Recursive formulations allow us to reduce often complex models to a sequence of essentially static problems that are easier to analyze both analytically and computationally. We first provide a self-contained treatment of the basic theory: the Revelation Principle, formulating and simplifying the incentive constraints, using promised utilities as state variables, and analyzing models with persistent shocks using the first-order approach. We then discuss more advanced topics: duality theory and Lagrange multiplier techniques, models with lack of commitment, and martingale methods in continuous time. Finally, we show how a variety of applications in public economics, corporate finance, development and international economics featuring incomplete risk sharing can be analyzed using the tools of the theory of recursive contracts.

Suggested Citation

  • Golosov, M. & Tsyvinski, A. & Werquin, N., 2016. "Recursive Contracts and Endogenously Incomplete Markets," Handbook of Macroeconomics, Elsevier.
  • Handle: RePEc:eee:macchp:v2-725
    DOI: 10.1016/bs.hesmac.2016.03.007
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    Cited by:

    1. Karaivanov, Alexander K. & Martin, Fernando M., 2018. "Markov-perfect risk sharing, moral hazard and limited commitment," Journal of Economic Dynamics and Control, Elsevier, vol. 94(C), pages 1-23.
    2. Philipp Renner & Simon Scheidegger, 2017. "Machine learning for dynamic incentive problems," Working Papers 203620397, Lancaster University Management School, Economics Department.
    3. Bloedel, Alex & Krishna, R. Vijay & Leukhina, Oksana, 2018. "Insurance and Inequality with Persistent Private Information," Working Papers 2018-20, Federal Reserve Bank of St. Louis.
    4. Jean Guillaume Forand & Jan Zapal, 2017. "The Demand and Supply of Favours in Dynamic Relationships," Working Papers 1705, University of Waterloo, Department of Economics, revised Sep 2017.
    5. Xavier Ragot & Francois Le Grand, 2017. "Optimal Fiscal Policy with Heterogeneous Agents and Aggregate Shocks," 2017 Meeting Papers 969, Society for Economic Dynamics.

    More about this item

    Keywords

    Principal–agent model; Dynamic mechanism design; Recursive contracts; Private information; Limited commitment; Incomplete markets; Revelation Principle; Promised utility; First-order approach; Hidden storage; Lagrangian; Continuous time contracts; A33; C61; D52; D82; D86; H21;

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • E2 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination

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