Periodic Reporting for period 3 - WIDE (Welfare, Incentives, Dynamics, and Equilibrium)
Okres sprawozdawczy: 2023-06-01 do 2024-11-30
Since the Wealth of Nations (Adam Smith,1776) and the Éléments d'économie politique pure (Léon Walras, 1874), economics endeavoured to study whether market forces can maximize welfare. This line of research culminated in the 1950s with the works of Ken Arrow and Gérard Debreu, who proved equilibrium is a social optimum when markets are complete and information symmetric. When these assumptions don’t hold, in particular because of information asymmetry, incentive constraints must be factored in. When these constraints are satisfied, agents can be trusted to act reliably and communicate truthful information. But, when these constraints bind, equilibrium can lead to socially suboptimal outcomes. The goal of my project (WIDE) is to develop further the equilibrium analysis of financial markets, organizations and corporate finance under incentive constraints, and obtain implications both for firm management and for welfare maximizing policies. The project includes 4 work packages, studying dynamic incentives and equilibrium in i) corporate finance, ii) organizations, iii) financial markets, and iv) taxation. Design optimal contracts, appropriately taking into account, is important for society because it helps mitigate the adverse consequences of information asymmetry and thus helps improve welfare.
As written my B1document the main goal of WP2 was to “study the dynamic equilibrium interaction between incentives and complexity and confront the theoretical results to the data.” This led to the paper, “Endogenous Agency Problems and the Dynamics of Rents” published in 2021 in the Review of Economic Studies, which shows how, labour market imperfections and moral hazard can lead to excessive complexity and rents.
As written in my B1 document, the goal of WP3 was to analyze the dynamic equilibrium consequences of incentive constraints. My paper, entitled “Incentive Constrained Risk Sharing, Segmentation, and Asset Pricing” and published at the American Economic Review in 2021, showed these constraints imply agents value assets differently, i.e. there is endogenous markets segmentation. Moreover, in equilibrium the price of a security is lower than that of replicating portfolios of long positions. Finally, equilibrium expected returns are concave in factor loadings.
As written in my B1 document, the goal of WP3 was to analyze the dynamic equilibrium consequences of incentive constraints. My paper, entitled “Incentive Constrained Risk Sharing, Segmentation, and Asset Pricing” and published at the American Economic Review in 2021, showed these constraints imply agents value assets differently, i.e. there is endogenous markets segmentation. Moreover, in equilibrium the price of a security is lower than that of replicating portfolios of long positions. Finally, equilibrium expected returns are concave in factor loadings.
As written in my B1 document regarding WP1, in previous work on dynamic contracts “to cope with the mathematical difficulty… simplifying assumptions were made, leading to highly stylized results… For instance, managers get paid infrequently and at random points in time… One of my goals is… to obtain more realistic implications from the model.” To do so, I am working on a model in which agents receive payments and consume in continuous time. Solving for the optimal contract is mathematically challenging, especially because, as written in my B1 document I am trying to “allow for cross-sectional heterogeneity” among firms. Yet progress has been made and I am hope to be able to characterize the optimum, which will be a significant progress beyond the state of the art.
For WP4, I consider a model in which taxation is imperfect, because agents privately observe their skills. Agents with better skills set up private businesses with greater expected profits but exposed to larger random shocks. Agents trade bonds to smooth out the impact of these shocks. Since transactions provide information about skills, it is optimal to tax them to relax incentive constraints. My goal is characterize the optimal tax mechanism, and its consequences on entrepreneurship and welfare, which will be a significant progress beyond the state of the art.
For WP4, I consider a model in which taxation is imperfect, because agents privately observe their skills. Agents with better skills set up private businesses with greater expected profits but exposed to larger random shocks. Agents trade bonds to smooth out the impact of these shocks. Since transactions provide information about skills, it is optimal to tax them to relax incentive constraints. My goal is characterize the optimal tax mechanism, and its consequences on entrepreneurship and welfare, which will be a significant progress beyond the state of the art.