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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
Bank liability insurance schemes before 1865
Weber, Warren E. (2010)
Prior to the Civil War several states established bank liability insurance schemes of two basic types. One was an insurance fund, in which member banks paid into a state-run fund that would pay losses of bank creditors. The other was a mutual guarantee system, in which survivor banks were legally responsible the liabilities of any bank that became insolvent. Both schemes did well at insuring bank creditors, but neither prevented bank panics. Bank failure rates were somewhat higher for banks that were part of these schemes. The experience with these schemes shows that regulatory incentives ...
Working Papers , Paper 679

Working Paper
The Optimal Taxation of Business Owners
Phelan, Tom (2019-11-19)
Business owners in the United States are disproportionately represented among the very wealthy and are exposed to substantial idiosyncratic risk. Further, recent evidence indicates business income primarily reflects returns to the human (rather than financial) capital of the owner. Motivated by these facts, this paper characterizes the optimal taxation of income and wealth in an environment where business income depends jointly on innate ability, luck, and the accumulated past effort exerted by the owner. I show that in (constrained) efficient allocations, more productive entrepreneurs ...
Working Papers , Paper 19-26

Journal Article
Bailouts
Green, Edward J. (2010-01)
Despite the cogent criticism that "bailing out" insolvent firms creates moral hazard, bailouts often occur in the aftermath of bank runs and other financial crises. In an environment where it is economically efficient to make illiquid investments, and where investors have private information regarding their respective liquidity risks, the investment contract must satisfy an incentive constraint. Limited liability tightens this constraint under laissez faire. In principle, government bailouts of insolvent firms might undo this adverse effect of limited liability. A theoretical example is ...
Economic Quarterly , Volume 96 , Issue 1Q , Pages 11-32

Working Paper
Optimal Social Insurance and Rising Labor Market Risk
Scheffel, Martin; Krebs, Tom (2019-02-01)
This paper analyzes the optimal response of the social insurance system to a rise in labor market risk. To this end, we develop a tractable macroeconomic model with risk-free physical capital, risky human capital (labor market risk) and unobservable effort choice affecting the distribution of human capital shocks (moral hazard). We show that constrained optimal allocations are simple in the sense that they can be found by solving a static social planner problem. We further show that constrained optimal allocations are the equilibrium allocations of a market economy in which the government ...
Opportunity and Inclusive Growth Institute Working Papers , Paper 18

Report
Are bank shareholders enemies of regulators or a potential source of market discipline?
Peristiani, Stavros; Park, Sangkyun (2001-09-01)
In moral hazard models, bank shareholders have incentives to transfer wealth from the deposit insurer--that is, maximize put option value--by pursuing riskier strategies. For safe banks with large charter value, however, the risk-taking incentive is outweighed by the possibility of losing charter value. Focusing on the relationship between book value, market value, and a risk measure, this paper develops a semi-parametric model for estimating the critical level of bank risk at which put option value starts to dominate charter value. From these estimates, we infer the extent to which the ...
Staff Reports , Paper 138

Discussion Paper
The Official Sector’s Response to the Coronavirus Pandemic and Moral Hazard
Kovner, Anna; Martin, Antoine (2020-09-24)
Any time the Federal Reserve or the official sector more broadly provides support to the economy during a crisis, the intervention raises concerns related to moral hazard. Moral hazard can occur when market participants do not bear the negative consequences of the risks they take. This lack of consequences can encourage even greater risks, due to the expectation of future government help. In this post, we consider the potential for moral hazard stemming from the official sector’s response to the coronavirus pandemic and explain why moral hazard concerns were likely more severe in 2008.
Liberty Street Economics , Paper 20200924

Working Paper
The Optimal Taxation of Business Owners
Phelan, Tom (2021-05-28)
Business owners in the United States are disproportionately represented among the wealthy and are exposed to substantial idiosyncratic risk. Further, recent evidence indicates that business income primarily reflects returns to the human capital of the owner. Motivated by these facts, this paper characterizes stationary efficient allocations and optimal linear taxes on income and wealth when business income depends on innate ability, luck, and the past effort of the owner. I first show that in stationary efficient allocations, more productive entrepreneurs typically bear more risk and the ...
Working Papers , Paper 19-26R

Discussion Paper
Introducing a Series on Large and Complex Banks
Morgan, Donald P. (2014-03-25)
The chorus of criticism levied against mega-banks has, in some cases, outrun the research needed to back the criticism. To help the research catch up with the rhetoric, financial economists here at the New York Fed have engaged in a systematic study of the economics of large and complex banks and their resolution in the event of failure. The result of those efforts is a collection of eleven papers, each of which was subject to review (internal and external). The papers are now online in our Economic Policy Review. Today, we begin a two-week series of posts that present the key findings of ...
Liberty Street Economics , Paper 201404325b

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