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Recursive contracts

  • Albert Marcet
  • Ramon Marimon

We obtain a recursive formulation for a general class of contracting problems involving incentive constraints. Under these constraints, the corresponding maximization (sup) problems fails to have a recursive solution. Our approach consists of studying the Lagrangian. We show that, under standard assumptions, the solution to the Lagrangian is characterized by a recursive saddle point (infsup) functional equation, analogous to Bellman's equation. Our approach applies to a large class of contractual problems. As examples, we study the optimal policy in a model with intertemporal participation constraints (which arise in models of default) and intertemporal competitive constraints (which arise in Ramsey equilibria).

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Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 337.

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Date of creation: Sep 1994
Date of revision: Oct 1998
Handle: RePEc:upf:upfgen:337
Contact details of provider: Web page: http://www.econ.upf.edu/

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