Long-Term Contracting in a Changing World
I study the properties of optimal long-term contracts in an environment in which the agents type evolves stochastically over time. The model stylizes a buyer-seller relationship but the results apply quite naturally to many contractual situations including regulation and optimal income-taxation. I rst show, through a simple example, that distortions need not vanish over time and need not be monotonic in the shock to the buyers valuation. These results are in contrast to those obtained in the literature that assumes a Markov process with a binary state space e.g. Battaglini, 2005. I then show that when the sets of possible types in any two adja- cent periods satisfy a certain overlapping condition (which is always satis ed with a continuum of types), then the dynamics of the optimal mechanism can be signi cantly simpli ed by as- suming the shocks are independent over time. Under certain regularity conditions, the optimal mechanism is then the same irrespective of whether the shocks are the buyers private informa- tion or are observed also by the seller. These conditions are satis ed, for example, in the case of an AR(1) process, a Brownian motion, but also when shocks have a multiplicative e¤ect as it is often the case in nancial applications. Furthermore, the distortions in the optimal quantities are independent of the distributions of the shocks and, when the buyers valuation is additively separable, they are also independent of whether the shocks are transitory or permanent. Finally, I show that assuming the shocks are independent not only greatly simpli es the analysis but is actually without loss of generality with a continuum of types.
|Date of creation:||Dec 2007|
|Date of revision:|
|Contact details of provider:|| Postal: Center for Mathematical Studies in Economics and Management Science, Northwestern University, 580 Jacobs Center, 2001 Sheridan Road, Evanston, IL 60208-2014|
Web page: http://www.kellogg.northwestern.edu/research/math/
More information through EDIRC
|Order Information:|| Email: |
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.:
- repec:oup:restud:v:74:y:2007:i:3:p:705-731 is not listed on IDEAS
- Marco Battaglini, 2003.
"Long-Term Contracting with Markovian Consumers,"
Theory workshop papers
505798000000000048, UCLA Department of Economics.
- Stephen Coate & Marco Battaglini, 2004.
"Pareto Efficient Income Taxation with Stochastic Abilities,"
2004 Meeting Papers
140, Society for Economic Dynamics.
- Battaglini, Marco & Coate, Stephen, 2008. "Pareto efficient income taxation with stochastic abilities," Journal of Public Economics, Elsevier, vol. 92(3-4), pages 844-868, April.
- Marco Battaglini & Stephen Coate, 2003. "Pareto Efficient Income Taxation with Stochastic Abilities," NBER Working Papers 10119, National Bureau of Economic Research, Inc.
- Pascal Courty & Li Hao, 1997. "Sequential screening," Economics Working Papers 224, Department of Economics and Business, Universitat Pompeu Fabra.
When requesting a correction, please mention this item's handle: RePEc:nwu:cmsems:1456. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Fran Walker)
If references are entirely missing, you can add them using this form.