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Using Persistence to Generate Incentives in a Dynamic Moral Hazard Problem

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  • Aislinn Bohren

    () (Department of Economics, University of Pennsylvania)

Abstract

This paper studies how persistence can be used to create incentives in a continuous-time stochastic game in which a long-run player interacts with a sequence of short-run players. Observation of the long-run player's actions are distorted by a Brownian motion and the actions of both players impact future payoffs through a state variable. For example, a firm or worker provides customers with a product, and the quality of this product depends on both current and past investment choices by the firm. I derive general conditions under which a Markov equilibrium emerges as the unique perfect public equilibrium, and characterize the equilibrium payoff and actions in this equilibrium, for any discount rate. I develop an application of persistent product quality to illustrate how persistence creates effective intertemporal incentives in a setting where traditional channels fail, and explore how the structure of persistence impacts equilibrium behavior. This demonstrates the power of the continuous-time setting to deliver sharp insights and a tractable equilibrium characterization for a rich class of dynamic games.

Suggested Citation

  • Aislinn Bohren, 2016. "Using Persistence to Generate Incentives in a Dynamic Moral Hazard Problem," PIER Working Paper Archive 16-024, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 15 Oct 2016.
  • Handle: RePEc:pen:papers:16-024
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Harry Pei, 2020. "Trust and Betrayals: Reputational Payoffs and Behaviors without Commitment," Papers 2006.08071, arXiv.org.
    2. Susan Athey & Andrzej Skrzypacz, 2017. "Yuliy Sannikov: Winner of the 2016 Clark Medal," Journal of Economic Perspectives, American Economic Association, vol. 31(2), pages 237-256, Spring.
    3. Aislinn Bohren, 2016. "Using Persistence to Generate Incentives in a Dynamic Moral Hazard Problem," PIER Working Paper Archive 16-024, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 15 Oct 2016.
    4. Dilmé, Francesc, 2019. "Reputation building through costly adjustment," Journal of Economic Theory, Elsevier, vol. 181(C), pages 586-626.
    5. Joao Ramos & Tomasz Sadzik, 2018. "Partnership with Persistence," 2018 Meeting Papers 1264, Society for Economic Dynamics.
    6. Gonzalo Cisternas, 2018. "Career Concerns and the Nature of Skills," American Economic Journal: Microeconomics, American Economic Association, vol. 10(2), pages 152-189, May.

    More about this item

    Keywords

    Continuous Time Games; Stochastic Games;

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance

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