Yale ECON 525 - Advanced Macroeconomics I (18 pages)

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Advanced Macroeconomics I



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Advanced Macroeconomics I

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Pages:
18
School:
Yale University
Course:
Econ 525 - Adv Macroeconomics I
Adv Macroeconomics I Documents

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Aghion and Bolton REStud 92 Diamond and Rajan JPE 01 Advanced Macroeconomics I ECON 525a Fall 2009 Yale University Guillermo L Ordon ez Week 3 Guillermo L Ordon ez Advanced Macroeconomics I ECON 525a Fall 2009 Yale University Aghion and Bolton REStud 92 Diamond and Rajan JPE 01 Main ideas Incomplete contracts call for unexpected situations that need decision to be taken Under misalignment of interests between E and L a contingent control allocation is optimal Standard debt contract is exactly this Default Control goes to L NO default Control remains for E Guillermo L Ordon ez Advanced Macroeconomics I ECON 525a Fall 2009 Yale University Aghion and Bolton REStud 92 Model E Diamond and Rajan JPE 01 REVIEW OF ECONOMIC STUDIES 476 promises an expected return to the investor of at least K she is willing to take the offer This defines the investor s individual rationality constraint The technological characteristics of this project are described in the time line shown in Figure 1 Thus the returns of the project are stochastic and depend on an action a chosen from the set of feasible actions A after the realization of a state of nature 0 0 is the needs K to start a project L is deep pockets set of possible states of nature E has all bargaining power Both are risk neutral Investment K Realization of state of nature 0 and signal s t 0 t 1 Realization of returns r tt 2 action a is taken FIGURE 1 Potential misalignment of interests Both the entrepreneur E and the investor I are risk neutral in income Their Von Neumann Morgenstern utility functions over income and action pairs are denoted that they take the following simple respectively by UE r a and UI r a U suppose r l a E r a We form 1 UE r a r l a O UL r a r U1 r a r 2 The investor is only interested in the monetary returns of the project The Everybody observes but cannot describe it ex ante entrepreneur who thought about the project and took the initiative of setting it up cares not only about the monetary returns but also



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