Thomas Mariotti

Strategic Ignorance as a Self-Disciplining Device

We analyse the decision of an agent with time-inconsistent preferences to consume a good that exerts an externality on future welfare. The extent of the externality is initially unknown, but may be learned via a costless sampling procedure. We show that when the agent cannot commit to future consumption and learning decisions, incomplete learning may occur on a Markov perfect equilibrium path of the resulting intra-personal game. In such a case, each agents incarnation stops learning for some values of the posterior distribution of beliefs and acts under self-restricted information. This conduct is interpreted as strategic ignorance. All equilibria featuring this property strictly Pareto dominate the complete learning equilibrium for any posterior distribution of beliefs.

Large risks, limited liability, and dynamic moral hazard

We study a continuous-time principal-agent model in which a risk-neutral agent with limited liability must exert unobservable effort to reduce the likelihood of large but relatively infrequent losses. Firm size can be decreased at no cost or increased subject to adjustment costs. In the optimal contract, investment takes place only if a long enough period of time elapses with no losses occurring. Then, if good performance continues, the agent is paid. As soon as a loss occurs, payments to the agent are suspended, and so is investment if further losses occur. Accumulated bad performance leads to downsizing. We derive explicit formulae for the dynamics of firm size and its asymptotic growth rate, and we provide conditions under which firm size eventually goes to zero or grows without bounds.

Subjective Discounting in an Exchange Economy

This paper describes the equilibrium of a discrete‐time exchange economy in which consumers with arbitrary subjective discount factors and homothetic period utility functions follow linear Markov consumption and portfolio strategies. Explicit expressions are given for state prices and consumption‐wealth ratios. We provide an analytically convenient continuous‐time approximation and show how subjective rates of time preference affect risk‐free rates but not instantaneous risk‐return trade‐offs. Hyperbolic discount factors can be a source of return volatility, but they cannot be used to address asset pricing puzzles related to high‐frequency Sharpe ratios.

Investment timing and learning externalities

Abstract We study a duopoly model of investment, in which each player learns about the quality of a common value project by observing some public background information, and possibly the experience of his rival. Investment costs are private information, and the background signal takes the form of a Poisson process conditional on the quality of the project being low. The resulting attrition game has a unique, symmetric equilibrium, which depends on initial public beliefs. We determine the impact of changes in the cost and signal distributions on investment timing, and how equilibrium is affected when a first-mover advantage is introduced.

Investment Timing Under Incomplete Information

We study the decision of when to invest in a project whose value is perfectly observable but driven by a parameter that is unknown to the decision maker ex ante. This problem is equivalent to an optimal stopping problem for a bivariate Markov process. Using filtering and martingale techniques, we show that the optimal investment region is characterized by a continuous and nondecreasing boundary in the value-belief state space. This generates path-dependency in the optimal investment strategy. We further show that the decision maker always benefits from an uncertain drift relative to an average drift situation and that the value of the option to invest is not globally increasing with respect to the volatility of the value process.

Electoral competition and politician turnover

Abstract In this paper, we analyze the selection by opportunistic parties of the candidates who run for election. We consider a setting with incomplete but symmetric information about the candidates’ abilities, in which electoral campaigns provide voters with additional information about candidates. Parties care only about selecting an appropriate candidate to win the election, while voters elect the best candidate conditional on their information. We first argue that in order to defeat an established very good candidate of its rival, a party may favor a new candidate with highly uncertain ability, rather than an established good candidate. Next, we establish that the discrepancy between the objective of parties and the objective of the electorate leads to inefficient conservatism in the selection of candidates, i.e. each party keeps its incumbents too often from the voters’ viewpoint.

Credit, Wages and Bankruptcy Laws

We study the impact of different bankruptcy laws in general equilibrium, taking into account the interactions between the credit and labour markets, as well as wealth heterogeneity. Soft bankruptcy laws often preclude liquidation, to avoid ex-post inefficiencies. This worsens credit rationing, depresses investment and reduces aggregate leverage. Yet, tough laws do not necessarily maximize social welfare or emerge from the legislative process. Relatively rich agents can invest irrespective of the law. They favour soft laws that exclude poorer entrepreneurs from the market and thus reduce labour demand and wages. This raises the pledgeable income of the entrepreneurs who still can raise funds, and thus lowers their liquidation rates and the associated inefficiencies. Hence, a soft law can maximize social welfare.

Auction and the informed seller problem

A seller possessing private information about the quality of a good attempts to sell it through a second-price auction with announced reserve price. The choice of a reserve price transmits information to the buyers. We characterize the equilibria with monotone beliefs of the resulting signalling game and show that they lead to a reduced probability of selling the good compared to the symmetric information situation. We compare the unique separating equilibrium of this signalling game to the equilibrium of a screening game in which an uninformed monopoly broker chooses the trading mechanism. We show that the ex-ante expected probability of trade may be larger with a monopoly broker, as well as the ex-ante total expected surplus.

Nonexclusive Competition in the Market for Lemons

We consider an exchange economy in which a seller can trade an endowment of a divisible good whose quality she privately knows. Buyers compete in menus of non-exclusive contracts, so that the seller may choose to trade with several buyers. In this context, we show that an equilibrium always exists and that aggregate equilibrium allocations are generically unique. Although the good offered by the seller is divisible, aggregate equilibrium allocations exhibit no fractional trades. In equilibrium, goods of relatively low quality are traded at the same price, while goods of higher quality may end up not being traded at all if the adverse selection problem is severe. This provides a novel strategic foundation for Akerlof’s (1970) results, which contrasts with standard competitive screening models postulating enforceability of exclusive contracts. Latent contracts that are issued but not traded in equilibrium turn out to be an essential feature of our construction.(This abstract was borrowed from another version of this item.)

Non-Exclusive Competition in the Market for Lemons

We consider an exchange economy in which a seller can trade an endowment of a divisible good whose quality she privately knows. Buyers compete in menus of non-exclusive contracts, so that the seller may choose to trade with several buyers. In this context, we show that an equilibrium always exists and that aggregate equilibrium allocations are generically unique. Although the good offered by the seller is divisible, aggregate equilibrium allocations exhibit no fractional trades. In equilibrium, goods of relatively low quality are traded at the same price, while goods of higher quality may end up not being traded at all if the adverse selection problem is severe. This provides a novel strategic foundation for Akerlofs (1970) results, which contrasts with standard competitive screening models postulating enforceability of exclusive contracts. Latent contracts that are issued but not traded in equilibrium turn out to be an essential feature of our construction.