Sustainable monetary policy and inflation expectations

The author shows that the short-term nominal interest rate can anchor private-sector expectations into low inflation more precisely, into the best equilibrium reputation can sustain. He introduces nominal asset markets in an infinite horizon version of the Barro-Gordon model. The author then analyzes the subset of sustainable policies compatible with any given asset price system at date t = 0. While there are usually many sustainable inflation paths associated with a given set of asset prices, the best sustainable inflation path is implemented if and only if the short-term nominal bond is priced at a certain discount rate. His results suggest that policy frameworks must also be evaluated on their ability to coordinate expectations.Inflation (Finance) ; Interest rates ; Asset pricing

Essays on Reputations and Dynamic Games

This dissertation consists of three essays on reputations and dynamic games. I investigate how incomplete information, Bayesian Learning and strategic behavior interplay in different dynamic settings. In Chapter 1, I study reputation effects between a long-lived seller and different short-lived buyers where buyers enter the market at random times and only observe a coarse public signal about past transactions. The signal measures the difference between the number of good and bad outcomes in a biased way: a good outcome is more likely to increase the signal than a bad outcome to decrease it. The seller has a short-run incentive to shirk, but makes high profits if it were possible to commit to high effort. I show if there is a small but positive chance that the seller is a commitment type who always exerts high effort and if information bias is large, equilibrium behavior of the seller exhibits cyclic reputation building and milking. The seller exerts high effort at some values of the signals in order to increase the chance of reaching a higher signal and build reputation. Once the seller builds up his reputation through reaching a high enough signal, he exploits it by shirking. In chapter 2, I study the reputation effect in which a long-lived player faces a sequence of uninformed short-lived players and the uninformed players receive informative but noisy exogenous signals about the type of the long-lived player. I provide an explicit lower bound on all Nash equilibrium payoffs of the long-lived player. The lower bound shows when the exogenous signals are sufficiently noisy and the long-lived player is patient, he can be assured of a payoff strictly higher than his minmax payoff. In Chapter 3 I study optimal dynamic monopoly pricing when a monopolist sells a product with unknown quality to a sequence of short-lived buyers who have private information about the quality. Because past prices and buyers’ purchase behavior convey information about private signals, they jointly determine the public belief about the quality of the monopolist’s product. The monopolist is essentially doing experimentation in the market because every price charged generates not only current period profit but also additional information about the quality. I focus on information structures with a continuum of signals. Under a mild regularity condition on information structures, I show that in equilibrium, the optimal price is an increasing function of the public beliefs. In addition, I fully characterize information cascade sets in terms of information structure. I find that the standard characterization in terms of boundedness of information structure in the social learning literature no longer holds in the presence of a monopoly. In fact, whether herding occurs or not depends more on the values of the conditional densities of the signals at the lowest signal

Comparative Statics in a Herding Model of Investment

This paper is an adaptation of the Chamley-Gale endogenous-timing information-revelation model of investment (Econometrica 1994). It models a game with pure informational externality where agents can learn by observing others' actions. The social learning can result in herding and possibly in an inefficient cascade. While Chamley and Gale characterize the equilibrium of such a game, this paper permits the derivation of comparative static results of the likelihood of inefficient cascades. This is useful for two reasons: First, the derivation of comparative static results in a model with endogenous timing provides a framework that may be useful in the analysis of a wide variety of applied issues. It is often argued that information cascades may help to explain a wide variety of economic issues including business cycles, bank runs, speculative attacks and IPO underpricing among others. However, it has proven difficult to move beyond the demonstration that herding may help explain these phenomena to analyze the welfare implications and policy tools available to decrease the likelihood of inefficient herding in these markets. This paper develops a framework that may be useful in providing a first pass in the analysis of these issues. Secondly, the analysis allows a deeper understanding of the relationship between exogenous and endogenous timing herding models. With endogenous timing the discount rate plays an important role in the determination of the probability of an inefficient cascade. This paper shows that as agents become more patient the probability of an inefficient negative cascade goes up. The relevant time for this discounting is the time to react to the decisions of others. Hence financial markets where agents can react quickly to the observed actions of others are likely to have relatively more inefficient negative cascades (inefficient collapses) than in real investment markets where agents observe and react to the actions of others with a longer delayHerding, Information cascade, Social Learning

Overcoming Incentive Constraints? The (In-)effectiveness of Social Interaction

We experimentally study behavior in a simple voting game where players have private information about their preferences. With random matching, subjects overwhelmingly follow the dominant strategy to exaggerate their preferences. Applying the linking mechanism suggested by Jackson and Sonnenschein (2005) captures nearly all achievable efficiency gains. Repeated interaction leads to significant gains in truthful representation and efficiency only if players can choose their partners.Experimental Economics, Mechanism Design, Implementation, Linking, Bayesian Equilibrium, Efficiency

Competition fosters trust

We study the effects of reputation and competition in a stylized market for experience goods. If interaction is anonymous, such markets perform poorly: sellers are not trustworthy, and buyers do not trust sellers. If sellers are identifiable and can, hence, build a reputation, efficiency quadruples but is still at only a third of the first best. Adding more information by granting buyers access to all sellers’ complete history has, somewhat surprisingly, no effect. On the other hand, we find that competition, coupled with some minimal information, eliminates the trust problem almost completely

How does informational heterogeneity affect the quality of forecasts?

We investigate a toy model of inductive interacting agents aiming to forecast a continuous, exogenous random variable E. Private information on E is spread heterogeneously across agents. Herding turns out to be the preferred forecasting mechanism when heterogeneity is maximal. However in such conditions aggregating information efficiently is hard even in the presence of learning, as the herding ratio rises significantly above the efficient-market expectation of 1 and remarkably close to the empirically observed values. We also study how different parameters (interaction range, learning rate, cost of information and score memory) may affect this scenario and improve efficiency in the hard phase.Comment: 11 pages, 5 figures, updated version (to appear in Physica A

Mechanisms of Endogenous Institutional Change

This paper proposes an analytical-cum-conceptual framework for understanding the nature of institutions as well as their changes. In doing so, it attempts to achieve two things: First, it proposes a way to reconcile an equilibrium (endogenous) view of institutions with the notion of agents’ bounded rationality by introducing such concepts as a summary representation of equilibrium as common knowledge of agents. Second, it specifies some generic mechanisms of institutional coherence and change -- overlapping social embededdness, Schumpeterian innovation in bundling games and dynamic institutional complementarities -- useful for understanding the dynamic interactions of economic, political, social and organizational factors.

Essays on the economic theory of managerial incentives

Corporations are very common in the business world. In this kind of organizations shareholders are protected by limited liability and, furthermore, they can easily transfer their shares. As a consequence, investors might be interested in buying a corporation's shares just to diversify their portfolios, without any real interest in getting involved in management. It is therefore much easier for corporations to obtain external finance than other organizational forms, and this might well be the basic reason for their wide diffusion. For the very same reason, however, it is necessary to hire professional managers to make all the relevant decisions, and this contains the seed of their problematic governance. In fact, the separation of ownership and control produces a conflict of interest between shareholders, interested in maximizing the firm value, and managers, who can be interested in pursuing a variety of different objectives (empire building, entrenchment, shirking, etc.). This dissertation is composed by three research papers dealing with the economics of managerial incentive provision. It is common to interpret the relationship between shareholders and managers as an agency relationship affected by both a moral hazard and adverse selection problem. Usually, managerial incentives are affected by several elements such as, for example, their compensation packages and career concerns, the internal monitoring of the board of directors, the external monitoring of the market for corporate control, etc. This dissertation suggests that it might be necessary to consider Overview 2 the interactions between alternative incentive mechanisms both to better understand their functioning and, at least as importantly, to help interpreting empirical observations. The first chapter, Paying for Observable Luck, proposes a simple hidden action model which explains recent empirical evidence of asymmetric benchmarking in managerial compensation: managers appear to be insulated from bad luck but not from good luck. The explanation hinges on the interaction between explicit contractual incentives and implicit incentives deriving from the possibility of bankruptcy. The second chapter, Career Concerns and Competitive Pressure, studies how the level of competition in the product market a ects the strength of managerial career concerns. Good managers are in short supply so that firms are willing to compete for them. However, the value of good managers depends on the profit differential they are able to produce on the product market. It is then shown that increased competition makes career concerns stronger if it increases such profit differential. The third chapter, Managerial Entrenchment and the Market for CEOs, suggests that the observed trends of increased managerial pay and increased board independence might be related. Boards captured by an entrenched managers are not active on the demand side of the managerial labor market. Therefore, increased board independence, reducing the number of captured boards, also increases competition for good managers, then rising their pay and making their career concerns stronger