Using Persistence to Generate Incentives in a Dynamic Moral Hazard Problem

Aislinn Bohren

PIER Working Paper Archive from Penn Institute for Economic Research, Department of Economics, University of Pennsylvania

Abstract: This paper studies how persistence can be used to create incentives in a continuous-time stochastic game in which a long-run player interacts with a sequence of short-run players. Observation of the long-run player's actions are distorted by a Brownian motion and the actions of both players impact future payoffs through a state variable. For example, a firm or worker provides customers with a product, and the quality of this product depends on both current and past investment choices by the firm. I derive general conditions under which a Markov equilibrium emerges as the unique perfect public equilibrium, and characterize the equilibrium payoff and actions in this equilibrium, for any discount rate. I develop an application of persistent product quality to illustrate how persistence creates effective intertemporal incentives in a setting where traditional channels fail, and explore how the structure of persistence impacts equilibrium behavior. This demonstrates the power of the continuous-time setting to deliver sharp insights and a tractable equilibrium characterization for a rich class of dynamic games.

Keywords: Continuous Time Games; Stochastic Games (search for similar items in EconPapers)
JEL-codes: C73 L1 (search for similar items in EconPapers)
Pages: 64 pages
Date: 2016-10-15, Revised 2016-10-15
New Economics Papers: this item is included in nep-gth and nep-mic
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Related works:
Working Paper: Using Persistence to Generate Incentives in a Dynamic Moral Hazard Problem (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:pen:papers:16-024

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