Jonathan P. Thomas

Informal Insurance Arrangements with Limited Commitment: Theory and Evidence from Village Economies

Recent work on consumption allocations in village economies finds that idiosyncratic variation in consumption is systematically related to idiosyncratic variation in income, thus rejecting the hypothesis of full risk-pooling. We attempt to explain these observations by adding limited commitment as an impediment to risk-pooling. We provide a general dynamic model and completely characterise efficient informal insurance arrangements constrained by limited commitment, and test the model using data from from three Indian villages. We find that the model can fully explain the dynamic response of consumption to income, but that it fails to explain the distribution of consumption across households.

Self-Enforcing Wage Contracts

We examine long-term wage contracts between a risk-neutral firm and a risk-averse worker when both can costlessly renege and buy or sell labour at a random spot market wage. A self-enforcing contract is one in which neither party ever has an incentive to renege. In the optimum self-enforcing contract, wages are sticky: they are less variable than spot market wages and positively serially correlated. They are updated by a simple rule: around each spot wage is a time invariant interval, and the contract wage changes each period by the smallest amount necessary to bring it into the current interval.

Income fluctuation and asymmetric information: an example of a repeated principal-agent problem

We examine a simple repeated principal-agent model with discounting. There are a risk averse borrower with an unobservable random income and a risk neutral lender. The efficient contract is characterized. It tends to the first-best (constant consumption) contract as the discount factor tends to one and the time horizon extends to infinity. If the time horizon is infinite and the contract is legally enforceable the borrower’s utility becomes arbitrarily negative with probability one. If the borrower has constant absolute risk aversion consumption is transferred between any two states at a constant interest rate which is less than the rate of time preference.

Foreign direct investment and the risk of expropriation

Foreign direct investment accounts for a considerable proportion of international capital flows. In 1986 the flow of foreign direct investment from developed market economies to developing countries was

IMF conditionality as a screening device

12.5 billion or roughly one-half of all private capital flows from the developed to the developing nations (and roughly one-quarter of the flow of all foreign direct investments). Its significance for developing countries may even grow in the future as debt is swapped for equity (see Pollio and Riemschneider, 1988). The most important sector in volume term is the manufacturing sector, the concern of this paper. In 1978 total stocks of manufacturing foreign direct investment accounted for roughly two-thirds of the total in less developed countries, with just one-eighth devoted to the extractive industries (see Stopford and Dunning, 1983, p.22).(This abstract was borrowed from another version of this item.)

REPUTATION AND EXPERIMENTATION IN REPEATED GAMES WITH TWO LONG-RUN PLAYERS

A theoretical model is developed in that both buybacks and the adoption of an IMF program can be used as screening devices that enable a creditor to discriminate between debtor countries that are willing to use debt relief in order to invest and repay and countries that are not. Asymmetric information is assumed. This problem can be solved if the country has sufficient resources to engage in a debt buyback and so gain the debt relief. When the country is credit constrained, an alternative screening mechanism is to undertake an IMF program in return for debt reduction and possibly an IMF loan.

The confidence heuristic: A game-theoretic analysis

The authors consider a repeated game between two long-run players, one of whom is relatively patient. Each player has a small amount of uncertainty about the others strategy. Given a weak assumption about the support of this uncertainty, the more patient player obtains (in any Nash equilibrium) approximately the highest payoff consistent with the individual rationality of the other player, if the latter is patient enough. If the less patient player is relatively impatient, any Nash equilibrium gives the more patient player at least the Stackelberg payoff: this generalizes K. M. Schmidts (1993) result, which applies only to games of conflicting interests.

Pooling sovereign risks: The case of environmental treaties and international debt

Abstract The paper analyzes two-person decision-making problems where information is asymmetric. A model is proposed in which information is revealed according to a social norm, whereby more confidently expressed arguments signal better information, and it is shown that efficient revelation of information can take place, and decision-making is based on expressed confidence (“the confidence heuristic”). This process leads to group polarization. The model is generalized to take account of the possibility that some individuals may act irrationally or in a prejudiced manner. If the number of prejudiced individuals in the population is sufficiently large, then the norm will break down.

An Analysis of Labour Adjustment Costs in Unionized Economies

A model is analysed in which a sovereign country has independent obligations to repay a creditor bank and to keep an environmental treaty. It is shown that the linkage of both obligations through a cross-default contract may reduce the sovereign risk attached to both the debt and the environmental contracts. Moreover, such a linkage will create an incentive for the sovereign and the bank to engage in a debt-for-natureswap, the anticipation of which increases the initial incentive for a cross-default contract to be entered into.

Sovereign debt: Ignorance can be bliss☆

In this paper we conduct a theoretical analysis of the implications of a union which can exploit the existence of firm labour adjustment costs. We consider a model involving a large number of identical firms facing a single, economy-wide union. We solve (i) for the Markov perfect equilibria with no commitment, under the assumption that the union chooses wages each period and firms react by choosing employment, and (ii) for the commitment equilibria where the union can precommit to the entire (infinite) sequence of wages. We conclude that the speed of adjustment of employment, that is higher in the no-commitment case, decreases with adjustment costs in both models. Moreover adjustment costs affect the long run values of employment and wages only in the no-commitment case, i.e., the higher the relevance of adjustment costs the higher the wage and therefore the smaller the level of employment in the long run. Commitment on the part of the union leads to lower wages, and moreover is beneficial to firms as well as to the union. Given that the union would like to commit to a lower path of wages we consider whether reputation building is desirable.