Optimal debt contracts and moral hazard along the business cycle

We analyze the Pareto optimal contracts between lenders and borrowers in a model with asymmetric information. The model generalizes the Rothschild-Stiglitz pure adverse selection problem by including moral hazard. Entrepreneurs with unequal “abilities” borrow to finance alternative investment projects which differ in degree of risk and productivity. We determine the endogenous distribution of projects as functions of the amount of loanable funds, when lenders have no information about borrowers’ ability and technological choices. Then, we embed these results in a dynamic competitive economy and show that the average quality of the selected projects in equilibrium may be high in recessions and low in booms. This phenomenon may generate (a) multiple steady states, (b) a smaller impact of exogenous shocks on output relative to the full information case, (c) endogenous fluctuations.We analyze the Pareto optimal contracts between lenders and borrowers in a model with asymmetric information. The model generalizes the Rothschild-Stiglitz pure adverse selection problem by including moral hazard. Entrepreneurs with unequal “abilities” borrow to finance alternative investment projects which differ in degree of risk and productivity. We determine the endogenous distribution of projects as functions of the amount of loanable funds, when lenders have no information about borrowers’ ability and technological choices. Then, we embed these results in a dynamic competitive economy and show that the average quality of the selected projects in equilibrium may be high in recessions and low in booms. This phenomenon may generate (a) multiple steady states, (b) a smaller impact of exogenous shocks on output relative to the full information case, (c) endogenous fluctuations.Refereed Working Papers / of international relevanc

Distribution Risk and Equity Returns

In this paper we entertain the hypothesis that observed variations in income shares are the result of changes in the balance of power between workers and capital owners in labor relations. We show that this view implies that income share variations represent a risk factor of ¯rst-order importance for the owners of capital and, consequently, are a crucial determinant of the return to equity. When both risks are calibrated to observations, this distribution risk dominates in importance the usual systematic risk for the pricing of assets. We also show that distribution risks may originate in non-traded idiosyncratic income shocks.Income shares; Distribution risk; equity premium; limited market participation

Distribution Risk and Equity Returns

In this paper we entertain the hypothesis that observed variations in income shares are the result of changes in the balance of power between workers and capital owners in labor relations. We show that this view implies that income share variations represent a risk factor of ¯rst-order importance for the owners of capital and, consequently, are a crucial determinant of the return to equity. When both risks are calibrated to observations, this distribution risk dominates in importance the usual systematic risk for the pricing of assets. We also show that distribution risks may originate in non-traded idiosyncratic income shocks.income shares; distribution risk; equity premium; limited market participation

Adverse Selection of Investment Projects and the Business Cycle

In an economy where entrepreneurs with unequal "abilities" face alternative investment projects, which differ in degree of risk and productivity, we analyse the Nash equilibrium contracts arising from a banks-borrowers game in the context of asymmetric information. We show that, for a particular characterization of the game, one can determine the endogenous distribution of projects and the "type" of contracts (pooling or separating) as functions of the amount of loanable funds. We set this game in a general equilibrium aggregative economy with production, populated by overlapping generations of borrowers and lenders and show that for a range of the parameter values equilibria are characterized by persistent endogenous cycles.adverse selection, business cycles, investment projects

General equilibrium, incomplete markets and sunspots: A symposium in honor of David Cass Guest editors' introduction

tutelage or worked with him on research have for him. Most scientists would be happy to have had one major, influential idea over the course of their careers. Dave Cass has had three, and is still going strong. His first major contribution to economics was the characterization of optimal growth trajectories in his thesis work under Hirofumi Uzawa's supervision. The celebrated Cass criterion for optimal time paths in the one good growth model quickly followed. The essence of this work is the search for price characterizations of efficiency for dynamic time paths, an effort that directly pointed the way to the subsequent full dynamic decentralization of the neoclassical optimal growth model, a fact that permits its use for modeling a wide range of business cycle and other macroeconomic phenomena. Accordingly, Dave is rightly honored, in conjunction with Tjalling Koopmans, not only as one of the founding fathers of optimal growth theory but also of dynamic modern macroeconomics, where the neoclassical growth model, in all its variations and interpretations, remains the fundamental underlying paradigm for all of dynamic macroeconomic analysis

Stability and sensitivity analysis of the secondary instability in the sphere wake

The three-dimensional flow past a fixed sphere placed within a uniform stream is investigated. This paper focuses on the second bifurcation, which is responsible for the onset of the unsteadiness. Using the highly efficient Nek5000 parallel solver together with a recently developed numerical algorithm to stabilize and accelerate the numerical solution, it was possible to identify the three-dimensional eigenmode responsible for the second bifurcation. The characteristics of this eigenmode are analyzed in detail. The value of the critical Reynolds number ReIIcr=271.8, as well as the Strouhal number of the arising limit cycle, agree well with previous experimental and numerical investigations. To further assess the nature of the instability, an adjoint-based sensitivity analysis is carried out. The structure of the direct and adjoint modes are discussed, and then the core of the instability is localized. Finally, the sensitivity of the instability to a generic base flow modification is investigated

Recursive Equilibrium in Stochastic Overlapping-Generations Economies

We prove the generic existence of a recursive equilibrium for overlapping-generations economies with uncertainty. "Generic" here means in a residual set of utilities and endowments. The result holds provided there is a sufficient number of potentially different individuals within each cohort. Copyright 2010 The Econometric Society.