Dynamic Mechanism Design with Hidden Income and Hidden Auctions

Robert Townsend and Matthias Doepke

No 4455, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We develop general recursive methods to solve for optimal contracts in dynamic principal-agent environments with hidden states and hidden actions. In our baseline model, the principal observes nothing other than transfers. Nevertheless, optimal incentive-constrained insurance can be attained. We show that the optimal contract can be implemented as a recursive direct mechanism with a vector of utility promises as the state variable. The standard recursive formulation suffers from a curse of dimensionality that arises from the interaction of hidden income and hidden actions; this curse can be overcome by introducing judiciously chosen utility bounds for deviation behaviour off the equilibrium path. Our methods generalize to environments with multiple actions and additional states. The key to implementing these extensions is to introduce multiple layers of off-path utility bounds.

Keywords: Mechanism design; Dynamic contracts; Recursive contracts (search for similar items in EconPapers)
JEL-codes: C73 D82 (search for similar items in EconPapers)
Date: 2004-06
References: Add references at CitEc
Citations: View citations in EconPapers (5)

Downloads: (external link)
https://cepr.org/publications/DP4455 (application/pdf)

Related works:
Journal Article: Dynamic mechanism design with hidden income and hidden actions (2006)
Working Paper: Dynamic Mechanism Design With Hidden Income and Hidden Actions (2002)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:4455

Ordering information: This working paper can be ordered from
https://cepr.org/publications/DP4455

Access Statistics for this paper

More papers in CEPR Discussion Papers from Centre for Economic Policy Research 33 Great Sutton Street, London EC1V 0DX, UK.
Bibliographic data for series maintained by CEPR ().