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Moral hazard, investment, and firm dynamics
We present a dynamic general equilibrium model with heterogeneous firms. Owners of firms delegate investment decisions to managers, whose consumption and investment decisions are private information. We solve the optimal contracts and characterize the implied general equilibrium. Our calibrated model has implications on the cross-sectional distribution and time-series dynamics of firms' investment, managers' compensation, and dividend payout policies. Risk sharing requires that managers' equity shares decrease with firm sizes. That, in turn, implies it is harder to prevent private benefit in larger firms, where managers have a lower equity stake under the optimal contract. Consequently, small firms invest more, pay less dividends, and grow faster than large firms. Despite the heterogeneity in firms' decision rules and the failure of Gibrat's law, we show that the size distribution of firms in our model resembles a power law distribution with a slope coefficient about 1.06, as in the data.
AUTHORS: Li, Rui; Ai, Hengjie
Smooth nonexpected utility without state independence
We propose a notion of smoothness of nonexpected utility functions, which extends the variational analysis of nonexpected utility functions to more general settings. In particular, our theory applies to state dependent utilities, as well as the multiple prior expected utility model, both of which are not possible in previous literatures. Other nonexpected utility models are shown to satisfy smoothness under more general conditions than the Frchet and Gateaux differentiability used in the literature. We give more general characterizations of monotonicity and risk aversion without assuming state independence of utility function.
AUTHORS: Ai, Hengjie
Asset Pricing with Endogenously Uninsurable Tail Risk
This paper studies asset pricing in a setting in which idiosyncratic risk in human capital is not fully insurable. Firms use long-term contracts to provide insurance to workers, but neither side can commit to these contracts; furthermore, worker-firm relationships have endogenous durations owing to costly and unobservable effort. Uninsured tail risk in labor earnings arises as a part of an optimal risk-sharing scheme. In the general equilibrium, exposure to the resulting tail risk generates higher risk premia, more volatile returns, and variations in expected returns across firms. Model outcomes are consistent with the cyclicality of factor shares in the aggregate, and the heterogeneity in exposures to idiosyncratic and aggregate shocks in the cross section.
AUTHORS: Ai, Hengjie; Bhandari, Anmol