Contracts and Markets

Author: Maretto, Guido Tulio Andrea

Year: 2010

Degree: Dissertation (Ph.D.)

Advisor: Ledyard, John O.

Committee Members: Ledyard, John O.; Echenique, Federico; Cvitanić, Jakša

Option: Social Science

DOI: 10.7907/FBS0-F288

Abstract

I merge the standard Principal Agent model with a CAPM-type financial market, to study the interactions of contracts and financial markets. I prove existence of equilibrium in two models, a more general economy allowing for hidden type and action under generic mean variance preferences and a hidden action economy with Markowitz mean-variance preferences. I study economies for which markets have an insurance effect on compensation contracts. I show sufficient conditions for lower variance to obtain in large economies, even with asymmetric information. In this context I show the effect of markets' size on efficiency. I also study moral hazard economies, for which I prove existence of a unique pure strategy equilibrium, and I show that financial markets negatively affect the equilibrium returns of firms. In the final chapter I study the efficiency of securities issued under symmetric information. I find that small markets and low correlation of firms' returns generate inefficiency. I also show that the assumption of symmetry or independence is crucial to obtaining the insurance results in the previous Chapters.

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