Sequential cost-reimbursement rules

This paper studies cost-sharing rules under dynamic adverse selection. We present a typical principal-agent model with two periods, set up in Laffont and Tirole's (1986) canonical regulation environment. At first, when the contract is signed, the firm has prior uncertainty about its efficiency parameter. In the second period, the firm learns its efficiency and chooses the level of cost-reducing effort. The optimal mechanism sequentially screens the firm's types and achieves a higher level of welfare than its static counterpart. The contract is indirectly implemented by a sequence of transfers, consisting of a fixed advance payment based on the reported cost estimate, and an ex-post compensation linear in cost performance.

Asset pricing when risk sharing is limited by default: a theoretical framework

We study the asset pricing implications of an endowment economy when agents can default on contracts that would leave them otherwise worse off. We specialize and extend the environment studied by Kocherlakota (1995) and Kehoe and Levine (1993) to make it comparable to standard studies of asset pricillg. We completely charactize efficient allocations for several special cases. We illtroduce a competitive equilibrium with complete markets alld with elldogellous solvency constraints. These solvellcy constraints are such as to prevent default -at the cost of reduced risk sharing. We show a version of the classical welfare theorems for this equilibrium definition. We characterize the pricing kernel, alld compare it with the one for economies without participation constraints : interest rates are lower and risk premia can be bigger depending on the covariance of the idiosyncratic and aggregate shocks. Quantitative examples show that for reasonable parameter values the relevant marginal rates of substitution fali within the Hansen-Jagannathan bounds.