We introduce uncertainty into Holmstrom and Milgrom (1987) to study optimal long-term contracting with learning. In a dynamic relationship, the agent's shirking not only reduces current performance, but also increases the agent's information rent due to the persistent belief manipulation effect. We characterize the optimal contract using the dynamic programming technique in which information rent is the unique state variable. In the optimal contract, the optimal effort is front-loaded and stochastically decreases over time. Furthermore, the optimal contract exhibits an option-like feature in that incentives increase after good performance. Implications about managerial incentives and asset management compensations are discussed.

We propose a dynamic model of investment and trade in a market of a specialized technology subject to two main frictions. First, agents cannot raise outside capital. Second, a random group of agents will have the opportunity to invest in new technology and these opportunities are not contractible. The first friction implies the presence of invesment cycles with abundant invesment and low returns in booms and little invesment and high returns in recessions. Only when the second friction is present invesment cycles are constrained inefficient. Often the inefficiency is two-sided with too much invesment in booms and too little in recessions from a social point of view. Interventions targetting only the underinvesment in recessions might make all agents worse off. Also, the two-sided inefficiency typically implies too volatile prices and too frequent realizations of abnormally low prices compared to fundamentals.

ABSTRACT We characterize equilibrium leverage dynamics in a trade‐off model in which the firm can continuously adjust leverage and cannot commit to a policy ex ante. While the leverage ratchet effect leads shareholders to issue debt gradually over time, asset growth and debt maturity cause leverage to mean‐revert slowly toward a target. Investors anticipate future debt issuance and raise credit spreads, fully offsetting the tax benefits of new debt. Shareholders are therefore indifferent toward the debt maturity structure, even though their choice significantly affects credit spreads, leverage levels, the speed of adjustment, future investment, and growth.

This paper develops a model to explain the widely used investment mandates in the institutional asset management industry based on two insights: first, giving a manager more investment flexibility weakens the link between fund performance and his effort in the designated market, and thus increases agency cost. Second, the presence of outside assets with negatively skewed returns can further increase the agency cost if the manager is incentivized to pursue outside opportunities. These effects motivate narrow mandates and tight tracking error constraints to most fund managers except those with exceptional talents. Our model sheds light on capital immobility and market segmentation that are widely observed in financial markets, and highlights important effects of negatively skewed risk on institutional incentive structures.

Measured as yield spreads against Treasury securities and AAA corporate bonds, the convenience premium of newly issued agency MBS averages more than half of the long-term Treasury convenience premium. The agency MBS convenience premium and issuance amount vary negatively with mortgage rate, consistent with a prepayment-driven channel. Placing agencies into conservatorship in 2008 and introducing liquidity regulations in 2013 significantly affected MBS convenience premium, consistent with government guarantee and regulatory treatment channels. Analyses of dispersion of dealers’ prepayment forecasts, seasoned MBS, and investors’ MBS holdings deliver further economic implications for agency MBS as safe assets.

A firm chooses its debt maturity structure and default timing dynamically, both without commitment. Via the fraction of newly issued short-term bonds, equity holders control the maturity structure, which affects their endogenous default decision. A shortening equilibrium with accelerated default emerges when cash flows deteriorate over time so that debt recovery is higher if default occurs earlier. Self-enforcing shortening and lengthening equilibria may coexist, with the latter possibly Pareto dominating the former. The inability to commit to issuance policies can worsen the Leland problem of the inability to commit to a default policy–a self-fulfilling shortening spiral and adverse default policy may arise. Received April 16, 2015; accepted February 20, 2016 by Editor Itay Goldstein.

This article analyzes the dynamic coordination problem among creditors of a firm with a time-varying fundamental and a staggered debt structure. In deciding whether to roll over his debt, each maturing creditor is concerned about the rollover decisions of other creditors whose debt matures during his next contract period. We derive a unique threshold equilibrium and characterize the roles of fundamental volatility, credit lines, and debt maturity in driving runs. In particular, we show that when fundamental volatility is sufficiently high, commonly used measures such as temporarily keeping the firm alive under runs and increasing debt maturity can exacerbate rather than mitigate runs.

We study an impatient, risk-neutral government that cannot commit to a particular debt path, financed by competitive lenders. In equilibrium, debt adjusts slowly toward a debt-to-income target, exacerbating booms and busts. Strikingly, gains from trade dissipate when trading is continuous, leaving the government no better off than in financial autarky, owing to a sovereign “debt ratchet effect.” Moreover, citizens who are more patient than their government are strictly harmed. We characterize equilibrium debt dynamics, ergodics, and comparative statics when income follows a geometric Brownian motion and analyze devices that allow the sovereign to recapture gains from trade.

Blockchain technology provides decentralized consensus and potentially enlarges the contracting space through smart contracts. Meanwhile, generating decentralized consensus entails distributing information that necessarily alters the informational environment. We analyze how decentralization relates to consensus quality and how the quintessential features of blockchain remold the landscape of competition. Smart contracts can mitigate informational asymmetry and improve welfare and consumer surplus through enhanced entry and competition, yet distributing information during consensus generation may encourage greater collusion. In general, blockchains sustain market equilibria with a wider range of economic outcomes. We further discuss the implications for antitrust policies targeted at blockchain applications.Received May 31, 2017; editorial decision May 29, 2018 by Editor Itay Goldstein.

We model the dynamics of risk premia during crises in asset markets where the marginal investor is a financial intermediary. Intermediaries face an equity capital constraint. Risk premia rise when the constraint binds, reflecting the capital scarcity. The calibrated model matches the nonlinearity of risk premia during crises and the speed of reversion in risk premia from a crisis back to precrisis levels. We evaluate the effect of three government policies: reducing intermediaries borrowing costs, injecting equity capital, and purchasing distressed assets. Injecting equity capital is particularly effective because it alleviates the equity capital constraint that drives the model's crisis. (JEL E44, G12, G21, G23, G24)