Disagreement and Learning in a Dynamic Contracting Model

41 Pages Posted: 6 Nov 2005 Last revised: 22 May 2008

See all articles by Tobias Adrian

Tobias Adrian

International Monetary Fund

Mark M. Westerfield

University of Washington

Multiple version iconThere are 3 versions of this paper

Date Written: May 2008

Abstract

We present a dynamic contracting model in which the principal and agent disagree about the resolution of uncertainty, and we illustrate the contract design in an application with Bayesian learning. The disagreement creates gains from trade that the principal realizes by transferring payment to states that the agent considers relatively more likely, changing incentives. The interaction between incentive provision and learning creates an intertemporal source of "disagreement risk" that alters optimal risk sharing. There is an endogenous regime shift between economies with small and large belief differences, and an early shock to beliefs can lead to large persistent differences in variable pay even after beliefs have converged. Under risk-neutrality, "selling the firm" to the agent does not implement the first-best because it precludes state-contingent trades.

Keywords: Dynamic Contracts, Heterogeneous Beliefs, Learning, Disagreement Risk, Principal-Agent, Continuous Time

JEL Classification: D0, D8, G0

Suggested Citation

Adrian, Tobias and Westerfield, Mark M., Disagreement and Learning in a Dynamic Contracting Model (May 2008). FRB of New York Staff Report No. 269; USC Marshall School of Business Research Paper. Available at SSRN: https://ssrn.com/abstract=1010844 or http://dx.doi.org/10.2139/ssrn.1010844

Tobias Adrian

International Monetary Fund ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

HOME PAGE: http://www.tobiasadrian.com

Mark M. Westerfield (Contact Author)

University of Washington ( email )

Box 353200
Seattle, WA 98195
United States

HOME PAGE: http://www.markwesterfield.com

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