Piero Gottardi

Efficient Competitive Equilibria with Adverse Selection

Do Walrasian markets function orderly in the presence of adverse selection? In particular, is their outcome efficient when exclusive contracts are enforceable? This paper addresses these questions in the context of a Rothschild‐Stiglitz insurance economy. We identify an externality associated with the presence of adverse selection as a special form of consumption externality. Consequently, we show that competitive equilibria always exist but are not typically incentive efficient. However, as markets for pollution rights can internalize environmental externalities, markets for consumption rights can be designed to internalize the consumption externality due to adverse selection. With such markets competitive equilibria exist and incentive‐constrained versions of the first and second welfare theorems hold.

Markets for Information: Of Inefficient Firewalls and Efficient Monopolies

In this paper we build a formal model to study market environments where information is costly to acquire and is of use also to potential competitors. In such situations a market for information may form, where reports - of unverifiable quality - over the information acquired are sold. A complete characterization of the equilibria of the game is provided. We find that information is acquired when its costs are not too high and in that case it is also sold, though reports are typically noisy. Also, the market for information tends to be a monopoly, and there is typically inefficiency given by underinvestment in information acquisition. Regulatory interventions in the form of firewalls, limiting the access to the sale of information to third parties, uninterested in trading the underlying object, only make the inefficiency worse. On the other hand, efficiency can be attained with a monopolist selling differentiated information, provided entry is blocked. The above findings hold when information has a prevalent horizontal differentiation component. When that is not the case, and the vertical differentiation element is more important, firewalls can in fact be beneficial.

Managerial Hedging and Portfolio Monitoring

Incentive compensation induces correlation between the portfolio of managers and the cash flow of the firms they manage. This correlation exposes managers to risk and hence gives them an incentive to hedge against the poor performance of their firms. We study the agency problem between shareholders and a manager when the manager can hedge his incentive compensation using financial markets and shareholders cannot perfectly monitor the manager’s portfolio in order to keep him from hedging the risk in his compensation. In particular, shareholders can monitor the manager’s portfolio stochastically, and since monitoring is costly governance is imperfect. If managerial hedging is detected, shareholders can seize the payoffs of the manager’s trades. We show that at the optimal contract: (i) the manager’s portfolio is monitored only when the firm performs poorly, (ii) the more costly monitoring is, the more sensitive is the manager’s compensation to firm performance, and (iii) conditional on the firm’s performance, the manager’s compensation is lower when his portfolio is monitored, even if no hedging is revealed by monitoring.

The Structure of Sunspot Equilibria: The Role of Multiplicity

This paper examines the structure of sunspot equilibria in a standard two period exchange economy with real assets. We show that for a generic choice of utility functions and endowments, there exists an open set of real asset structures whose payoffs are independent of sunspots such that the economy with this asset structure has a regular sunspot equilibrium. An important implication of our result is that the multiplicity of non-sunspot equilibria is not necessary for the existence of sunspot equilibria. Our technique is general and can be applied to show the existence of sunspot equilibria in other frameworks.

The relevance of financial policy

When the asset market is incomplete, equilibrium allocations are not invariant to changes in the financial policies of firms: in the presence of secondary assets, such as options, whose payoffs depend nonlinearly on the price of equity, the range of attainable reallocations of revenue varies as a firm alters its position in the asset market. Corporate financial policy is thus relevant. When assets are nominal, monetary policy implemented through open market operations is also effective.

Value of Information in Competitive Economies with Incomplete Markets

A substantial literature addresses the negative eect on welfare of the release of information in a competitive market economy. We show that the value of information in this setting is typically positive if asset markets are suciently incomplete. More specically, for any competitive equilibrium of a generic economy, we can nd a ner information structure such that an allocation that is resource feasible and measurable with respect to this information ex- post Pareto dominates the given equilibrium allocation.

Equilibrium corporate finance

We study a general equilibrium model with production where financial markets are incomplete. At a competitive equilibrium firms take their production and financial decisions so as to maximize their value. We show that shareholders unanimously support value maximization. Furthermore, competitive equilibria are constrained Pareto efficient. Finally the Modigliani-Miller theorem typically does not hold and the firms’ corporate financing structure is determined at equilibrium. Such results extend to the case where informational asymmetries are present and contribute to determine the firms’ capital structure.

Comment on "Bertrand and Walras Equilibria under Moral Hazard"

After completing the first version of this comment (September 2003), we became aware of a paper (Rustichini and Siconolfi 2003) in which a point similar to ours is made. We wish to thank the editor, Robert Shimer, and two anonymous referees for very helpful comments. Financial support from the Ministry for University and Research (project 2005135328_002) and the School for Advanced Studies in Venice to Gottardi and Fundacio ´n Ramo´n Areces and Spanish Direccio´n General de Ciencia y Tecnologi´a (projects SEJ2004-07861 and HI2001-0039 and Ramo´n y Cajal Program) to Jerez is gratefully acknowledged.

Efficiency properties of rational expectations equilibria with asymmetric information

In this paper we provide a characterization of the welfare properties of rational expectations equilibria of economies in which, prior to trading, agents have some information over the realization of uncertainty. We study a model with asymmetrically informed agents, treating symmetric information as a limiting case. Trade takes place in asset markets that may or may not be complete. We show that equilibria are characterized by two forms of inefficiency, price inefficiency and spanning inefficiency, and that generically both of them are present. Price inefficiency arises whenever equilibrium prices reveal some information. It formalizes and generalizes the so-called Hirshleifer effect, by showing that generically an interim Pareto improvement is possible even conditional on the information that is available to agents in equilibrium; the primary source of the inefficiency is a pecuniary externality. Spanning inefficiency, on the other hand, arises if prices are not fully revealing and markets are incomplete relative to the uncertainty faced by agents in equilibrium. In this case, an ex-post improvement can generically be implemented by providing agents with more information, thus expanding their risk-sharing opportunities and reducing informational asymmetries, even though this additional information restricts the set of allocations that are incentive compatible and individually rational.

A note on the regularity of competitive equilibria and asset structures

Abstract In this note we show that if markets are complete, the regularity of a given equilibrium allocation is invariant not only with respect to the choice of the system of equations describing the equilibrium but also with respect to the specification of the asset payoffs supporting the same equilibrium. On the other hand, if markets are incomplete regularity is typically not invariant with respect to the specification of the asset payoffs supporting a given equilibrium allocation. A sufficient condition for invariance is presented.