Optimal Delegated Search with Adverse Selection and Moral Hazard

The paper studies a model of delegated search. The distribution of search revenues is unknown to the principal and has to be elicited from the agent in order to design the optimal search policy. At the same time, the search process is unobservable, requiring search to be self-enforcing. The two information asymmetries are mutually enforcing each other; if one is relaxed, delegated search is efficient. With both asymmetries prevailing simultaneously, search is almost surely inefficient (it is stopped too early). Second-best remuneration is shown to optimally utilize a menu of simple bonus contracts. In contrast to standard adverse selection problems, indirect nonlinear tariffs are strictly dominated

Optimal Delegated Search with Adverse Selection and Moral Hazard

The paper studies a model of delegated search. The distribution of search revenues is unknown to the principal and has to be elicited from the agent in order to design the optimal search policy. At the same time, the search process is unobservable, requiring search to be self-enforcing. The two information asymmetries are mutually enforcing each other; if one is relaxed, delegated search is efficient. With both asymmetries prevailing simultaneously, search is almost surely inefficient (it is stopped too early). Second-best remuneration is shown to optimally utilize a menu of simple bonus contracts. In contrast to standard adverse selection problems, indirect nonlinear tariffs are strictly dominated

Optimal Delegated Search with Adverse Selection and Moral Hazard

The paper studies a model of delegated search. The distribution of search revenues is unknown to the principal and has to be elicited from the agent in order to design the optimal search policy. At the same time, the search process is unobservable, requiring search to be self-enforcing. The two information asymmetries are mutually enforcing each other; if one is relaxed, delegated search is efficient. With both asymmetries prevailing simultaneously, search is almost surely inefficient (it is stopped too early). Second-best remuneration is shown to optimally utilize a menu of simple bonus contracts. In contrast to standard adverse selection problems, indirect nonlinear tariffs are strictly dominated

Endogenous Second Moments: A Unified Approach to Fluctuations in Risk, Dispersion, and Uncertainty

Many important statistics in macroeconomics and finance—such as cross-sectional dispersions, risk, volatility, or uncertainty—are second moments. In this paper, we explore a mechanism by which second moments naturally and endogenously fluctuate over time as nonlinear transformations of fundamentals. Specifically, we provide general results that characterize second moments of transformed random variables when the underlying fundamentals are subject to distributional shifts that affect their means, but not their variances. We illustrate the usefulness of our results with a series of applications to (1) the cyclicality of the cross-sectional dispersions of macroeconomic variables, (2) the dispersion of MRPKs, (3) security pricing, and (4) endogenous uncertainty in Bayesian inference problems

Emergence and Persistence of Extreme Political Systems

We investigate the dynamics of political systems in a framework where transitions are driven by reforms and revolts, and where political systems are a priori unconstrained, ranging continuously from single-man dictatorships to full-scale democracies. The dynamics are governed by the likelihood of transitions and their outcome, which are both determined endogenously. We find that reforms and revolts result in extreme political systems - reforms by enfranchising the majority of the population leading to democracies, and revolts by installing autocracies. Reinforcing this polarization, extreme political systems are persistent across time: Democracies are intrinsically stable, leading to long episodes without political change. Autocracies, in contrast, are subject to frequent regime changes. Nevertheless they are persistent, since ensuing revolts lead to autocracies comparable to their predecessors. Taken together, our results suggest that the long-run distribution of political systems is bimodal with mass concentrated on the extremes. The dynamics are consistent with cross-country data

Robust Predictions for DSGE Models with Incomplete Information

We study the quantitative potential of DSGE models with incomplete information. In contrast to existing literature, we offer predictions that are robust across all possible private information structures that agents may have. Our approach maps DSGE models with information-frictions into a parallel economy where deviations from fullinformation are captured by time-varying wedges. We derive exact conditions that ensure the consistency of these wedges with some information structure. We apply our approach to an otherwise frictionless business cycle model where firms and households have incomplete information. We show how assumptions about information interact with the presence of idiosyncratic shocks to shape the potential for confidence-driven fluctuations. For a realistic calibration, we find that correlated confidence regarding idiosyncratic shocks (aka “sentiment shocks”) can account for up to 51 percent of U.S. business cycle fluctuations. By contrast, confidence about aggregate productivity can account for at most 3 percent

Endogenous Uncertainty and Credit Crunches

We develop a theory of endogenous uncertainty where the ability of investors to learn about firm-level fundamentals declines during financial crises. At the same time, higher uncertainty reinforces financial distress, causing a persistent cycle of uncertainty, pessimistic expectations, and financial constraints. Through this channel, a temporary shortage of funds can develop into a long-lasting funding problem for firms. Financial crises are characterized by increased credit misallocation, volatile asset prices, high risk premia, an increased cross-sectional dispersion of returns, and high levels of disagreement among forecasters. A numerical example suggests that the proposed channel may significantly delay recovery from financial shocks

Information-driven Business Cycles: A Primal Approach

We develop a methodology to characterize equilibrium in DSGE models, free of parametric restrictions on information. First, we define a “primal” economy in which deviations from full information are captured by wedges in agents' expectations. Then, we provide conditions ensuring some information-structure can implement these wedges. We apply the approach to estimate a business cycle model where firms and households have dispersed information. The estimated model fits the data, attributing the majority of fluctuations to a single shock to households' expectations. The responses are consistent with an implementation in which households become optimistic about local productivities and gradually learn about others' optimism

Dynamics of Political Systems

We develop a model of regime dynamics that embeds the principal transition scenarios examined by the literature. Political systems are a priori unrestricted and dynamics emerge through the combination and interaction of transition events over time. The model attributes a key role to beliefs held by political outsiders about the vulnerability of regimes, governing the likelihood and outcome of transitions. In equilibrium, transition likelihoods are declining in a regime's maturity,generating episodes of political stability alternating with rapid successions of revolts, counter revolts, and reforms. The stationary distribution of regimes is bimodal. The model dynamics match the data remarkably well

"Endogenous Uncertainty and Credit Crunches"

We develop a theory of endogenous uncertainty where the ability of investors to learn about firm-level fundamentals declines during financial crises. At the same time, higher uncertainty reinforces financial distress of firms, giving rise to “belief traps”— a persistent cycle of uncertainty, pessimistic expectations, and financial constraints, through which a temporary shortage of funds can develop into a long-lasting funding problem for firms. At the macro-level, belief traps provide a rationale for the long-lasting recessions that typically entail financial crises. In our model, financial crises are characterized by high levels of credit misallocation, an increased cross-sectional dispersion of growth rates, endogenously increased pessimism, uncertainty and disagreement among investors, highly volatile asset prices, and high risk premia. A calibration of our model to U.S. micro data on investor beliefs matches the slow recovery after the 08/09 crisis remarkably well