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Working Paper
Screening and adverse selection in frictional markets
Lester, Benjamin; Venkateswaran, Venky; Shourideh, Ali; Zetlin-Jones, Ariel (2016-03-10)
We incorporate a search-theoretic model of imperfect competition into an otherwise standard model of asymmetric information with unrestricted contracts. We develop a methodology that allows for a sharp analytical characterization of the unique equilibrium and then use this characterization to explore the interaction between adverse selection, screening, and imperfect competition. On the positive side, we show how the structure of equilibrium contracts?and, hence, the relationship between an agent?s type, the quantity he trades, and the corresponding price?is jointly determined by the severity ...
Working Papers , Paper 16-10

Working Paper
Financial Contracting with Enforcement Externalities
Drozd, Lukasz A.; Serrano-Padial, Ricardo (2018-10-18)
We study the negative feedback loop between the aggregate default rate and the efficacy of enforcement in a model of debt-financed entrepreneurial activity. The novel feature of our model is that enforcement capacity is accumulated ex ante and thus subject to depletion ex post. We characterize the effect of shocks that deplete enforcement resources on the aggregate default rate and credit supply. In the model default decisions by entrepreneurs are strategic complements, leading to multiple equilibria. We propose a global game selection to overcome equilibrium indeterminacy and show how shocks ...
Working Papers , Paper 18-21

Report
Zero Settlement Risk Token Systems
Lee, Michael Junho; Martin, Antoine; Townsend, Robert M. (2024-09-01)
How might modern settlement systems with distributed ledger technology achieve zero settlement risk? We consider the design of settlement systems that satisfies two integral features: information-leakage proof and zero settlement risk. Legacy settlement systems partition private information but are vulnerable to settlement fails. A token system with dynamic ownership representation, or a dynamic ledger, can be designed to achieve both, as long as it employs a protocol that enforces two restrictions: programs must be immediately implemented and must involve transactions based on verifiable ...
Staff Reports , Paper 1120

Working Paper
Optimal Long-Term Contracting with Learning
Wei, Bin; Yu, Jianfeng; He, Zhiguo; Gao, Feng (2016-11-01)
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 ...
FRB Atlanta Working Paper , Paper 2016-10

Working Paper
Managerial Compensation under Privately-Observed Hedging
Sun, Bo; Liu, Qi (2016-03)
This paper studies how private information in hedging outcomes affects the design of managerial compensation when hedging instruments serve as a double-edged sword in that they may be used for both corporate hedging and earnings management. On the one hand, financial vehicles can offer customized contracts that are closely tailored to manage specific risk and improve hedging efficiency. On the other hand, involvement in hedging may give rise to manipulation through misstatement of the value estimates. We show that the use of privately-observed hedging may actually require greater ...
International Finance Discussion Papers , Paper 1160

Working Paper
Financial contracting with enforcement externalities
Drozd, Lukasz A.; Serrano-Padial, Ricardo (2016-01-20)
Contract enforceability in financial markets often depends on the aggregate actions of agents. For example, high default rates in credit markets can delay legal enforcement or reduce the value of collateral, incentivizing even more defaults and potentially affecting credit supply. We develop a theory of credit provision in which enforceability of individual contracts is linked to aggregate behavior. The central element behind this link is enforcement capacity, which is endogenously determined by investments in enforcement infrastructure. Our paper sheds new light on the emergence of credit ...
Working Papers , Paper 16-1

Working Paper
Contingent Debt and Performance Pricing in an Optimal Capital Structure Model with Financial Distress and Reorganization
Grochulski, Borys; Wong, Russell (2018-11-14)
Building on the trade-off between agency costs and monitoring costs, we develop a dynamic theory of optimal capital structure with financial distress and reorganization. Costly monitoring eliminates the agency friction and thus the risk of inefficient liquidation. Our key assumption is that monitoring cannot be applied instantaneously. Rather, transitions between agency and monitoring are subject to search frictions. In the optimal contract, the firm seeks a monitoring opportunity whenever it is financially distressed, i.e., when the risk of liquidation is high. If a monitoring opportunity ...
Working Paper , Paper 18-17

Working Paper
Investment and Bilateral Insurance
Espino, Emilio; Sanchez, Juan M.; Kozlowski, Julian (2013-01-02)
Private information may limit insurance possibilities when two agents get together to pool idiosyncratic risk. However, if there is capital accumulation, bilateral insurance possibilities may improve because misreporting distorts investment. We show that if one of the Pareto weights is sufficiently large, that agent does not have incentives to misreport. This implies that, under some conditions, the full information allocation is incentive compatible when agents have equal Pareto weights. In the long run, either one of the agents goes to immiseration, or both agents’ lifetime utilities are ...
Working Papers , Paper 2013-001

Working Paper
Dynamic Pricing of Credit Cards and the Effects of Regulation
Serfes, Konstantinos; Hunt, Robert M.; Hong, Suting (2018-11-07)
We construct a two-period model of revolving credit with asymmetric information and adverse selection.In the second period, lenders exploit an informational advantage with respect to their own customers. Those rents stimulate competition for customers in the first period. The informational advantage the current lender enjoys relative to its competitors determines interest rates, credit supply, and switching behavior. We evaluate the consequences of limiting the repricing of existing balances as implemented by recent legislation. Such restrictions increase deadweight losses and reduce ex ante ...
Working Papers , Paper 18-23

Working Paper
Optimal Delegation Under Unknown Bias: The Role of Concavity
Tanner, Noam (2018-03-30)
A principal is uncertain of an agent's preferences and cannot provide monetary transfers. The principal, however, does control the discretion granted to the agent. In this paper, we provide a simple characterization of when it is optimal for the principal to screen by offering different terms of discretion to the agent. When the principal's utility is sufficiently concave, it is optimal for the principal to pool and to offer all agents the same discretion. Thus, for any number of agents and any distribution over agent preferences, the optimal contract is simple: the principal sets a cap and ...
Supervisory Research and Analysis Working Papers , Paper RPA 18-1

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