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Working Paper
Optimal Long-Term Contracting with Learning
We introduce uncertainty into Holmstrom and Milgrom (1987) to study optimal long-term contracting with learning. In a dynamic relationship, the agent's shirking not only reduces current performance but also increases the agent's information rent due to the persistent belief manipulation effect. We characterize the optimal contract using the dynamic programming technique in which information rent is the unique state variable. In the optimal contract, the optimal effort is front-loaded and decreases stochastically over time. Furthermore, the optimal contract exhibits an option-like feature in ...
Working Paper
Overconfidence, Subjective Perception, and Pricing Behavior
We study the implications of overconfidence for price setting in a monopolistic competition setup with incomplete information. Our price-setters overestimate their abilities to infer aggregate shocks from private signals. The fraction of uninformed firms is endogenous; firms can obtain information by paying a fixed cost. We find two results: (1) overconfident firms are less inclined to acquire information, and (2) prices might exhibit excess volatility driven by nonfundamental noise. We explore the empirical predictions of our model for idiosyncratic price volatility.
Working Paper
The Effect of Safe Assets on Financial Fragility in a Bank-Run Model
Risk-averse investors induce competitive intermediaries to hold safe assets, thereby lowering the probability of a run and reducing financial fragility. We revisit Goldstein and Pauzner (2005), who obtain a unique equilibrium in the banking model of Diamond and Dybvig (1983) by introducing risky investment and noisy private signals. We show that, in the optimal demand-deposit contract subject to sequential service, banks hold safe assets to insure investors against investment risk. Consequently, fewer investors withdraw prematurely, which reduces the probability of a bank run. Safe asset ...
Working Paper
Can Reputation Ensure Efficiency in the Structured Finance Market? Majority Voting: A Quantitative Investigation
In Elamin (2013), the credit rating agency (CRA) cannot credibly fully reveal its information about the quality of a rated structured finance project, when ratings are unverifiable. Can the fear of losing its reputation discipline the CRA? In this paper, there is incomplete information about the type of the CRA. With some probability, it can be a truthful type, always fully revealing its information. At every period, the (updated) probability that the CRA is of the truthful type is its reputation. With only two project types and when the CRA?s reputation is high enough, an informationally ...
Working Paper
Supply Chain Networks and the Macroeconomic Expectations of Firms
In a randomized control trial of customer-supplier firm pairs in New Zealand, we treat with information one firm in a pair and analyze the treatment's effects on the expectations and actions of both the directly treated firms (direct effect) and connected firms that did not directly receive information (spillover effect). The direct and spillover effects on expectations and actions are significant and of comparable magnitude. Higher expected future real GDP growth increases prices and employment, while greater uncertainty about it reduces prices, investment, and employment. We show that ...
Working Paper
Banking on Experience. Capital Reallocation, Asset Knowledge, and the Structure of Credit Contracts
The firm sector continuously engages in the reallocation of physical capital. We study the implications for credit market outcomes of banks' engagement in borrowing firms' capital reallocation. We develop a model in which banks' experience with the reallocation opportunities of physical capital raises their ability to recover liquidation values after firm defaults and asset reallocations, diluting banks' incentives to monitor borrowers. To test the model, we then construct an empirical measure of banks' engagement in capital reallocation using US loan-level data matched with firm-level data ...
Working Paper
Do You Even Crypto, Bro? Cryptocurrencies in Household Finance
Using repeated large-scale surveys of US households, we study the cryptocurrency investment decisions and motives of households relative to other financial assets. Cryptocurrency holders tend to be young, male, and more libertarian relative to non-crypto holders. Crypto holders expect much higher rates of return for crypto and perceive it as relatively safer than non-holders do. For those holding cryptocurrencies, changes in Bitcoin prices translate into their purchases of durable goods. Finally, information about historical returns of cryptocurrencies in an information provision experiment ...
Working Paper
Consumers' Attention to Monetary Policy: The Importance of Having "Skin in the Game"
Using a five-year survey of over 170,000 US consumers, we provide a novel direct measure of attention to monetary policy and show that the data strongly support the predictions of a rational inattention model. First, attention is incentive-driven: consumers with "skin in the game"—those planning major purchases like homes or cars—are significantly more attentive to monetary policy news. Second, attention varies systematically with interest rate volatility and news supply, exhibiting cyclical patterns around FOMC meetings. Third, marginal effects of volatility and news supply decline with ...
Working Paper
Understanding the Aggregate Effects of Credit Frictions and Uncertainty
We examine the interaction of uncertainty and credit frictions in a New Keynesian framework. To do so, uncertainty is modeled as time-varying stochastic volatitlity - the product of monetary policy uncertainty, financial risk (micro-uncertainty), and macrouncertainty. The model is solved using a pruned third-order approximation and estimated by the Simulated Method of Moments. We find that: 1) Micro-uncertainty aggravates the information asymmetry between lenders and borrowers, worsens credit conditions, and has first-order effects on real economic activity. 2) When credit conditions are ...
Working Paper
Rationally Inattentive Consumer: An Experiment
This paper presents a laboratory experiment that directly tests the theoretical predictions of consumption choices under rational inattention. Subjects are asked to select consumption when income is random. They can optimally decide to reduce uncertainty about income by acquiring signals about it. The informativeness of the signals directly relates to the cognitive effort required to process the information. We find that subjects? behavior is largely in line with the predictions of the theory: 1) Subjects optimally make stochastic consumption choices; 2) They respond to incentives and changes ...