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Using Persistence to Generate Incentives in a Dynamic Moral Hazard Problem

Author

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  • Aislinn Bohren

    (Department of Economics, University of Pennsylvania)

Abstract
I study how the persistence of past choices can be used to create incentives in a continuous time stochastic game in which a large player, such as a ï¬ rm, interacts with a sequence of short-run players, such as customers. The long-run player faces moral hazard and her past actions are imperfectly observed – they are distorted by a Brownian motion. Persistence refers to the fact that actions impact a payoffrelevant state variable, e.g. the quality of a product depends on both current and past investment choices. I obtain a characterization of actions and payoffs in Markov Perfect Equilibria (MPE), for a ï¬ xed discount rate. I show that the perfect public equilibrium (PPE) payoff set is the convex hull of the MPE payoff set. Finally, I derive sufficient conditions for a MPE to be the unique PPE. Persistence creates effective intertemporal incentives to overcome moral hazard in settings where traditional channels fail. Several applications illustrate how the structure of persistence impacts the strength of these incentives.

Suggested Citation

  • Aislinn Bohren, 2018. "Using Persistence to Generate Incentives in a Dynamic Moral Hazard Problem," PIER Working Paper Archive 18-015, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 01 Apr 2018.
    • Handle: RePEc:pen:papers:18-015
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    References listed on IDEAS

    as
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    Cited by:

    1. Joao Ramos & Tomasz Sadzik, 2018. "Partnership with Persistence," 2018 Meeting Papers 1264, Society for Economic Dynamics.
    2. Susan Athey & Andrzej Skrzypacz, 2017. "Yuliy Sannikov: Winner of the 2016 Clark Medal," Journal of Economic Perspectives, American Economic Association, vol. 31(2), pages 237-256, Spring.
    3. Gonzalo Cisternas, 2018. "Career Concerns and the Nature of Skills," American Economic Journal: Microeconomics, American Economic Association, vol. 10(2), pages 152-189, May.
    4. Aislinn Bohren, 2016. "Using Persistence to Generate Incentives in a Dynamic Moral Hazard Problem," PIER Working Paper Archive 16-024, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 15 Oct 2016.
    5. Harry Pei, 2020. "Trust and Betrayals: Reputational Payoffs and Behaviors without Commitment," Papers 2006.08071, arXiv.org.
    6. Dilmé, Francesc, 2019. "Reputation building through costly adjustment," Journal of Economic Theory, Elsevier, vol. 181(C), pages 586-626.
    7. Bohren, J. Aislinn, 2024. "Persistence in a dynamic moral hazard game," Theoretical Economics, Econometric Society, vol. 19(1), January.

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    More about this item

    Keywords

    Continuous Time Games; Stochastic Games; Moral Hazard;
    All these keywords.

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance

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