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Contract Renewal Under Uncertainty

Working Paper No. 1997-5

34 Pages Posted: 11 Aug 1997  

Torben M. Andersen

University of Aarhus - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR); IZA Institute of Labor Economics

Morten Stampe Christensen

University of Aarhus - Department of Economics

Date Written: September 1996

Abstract

The incentive to call for contract renewal to adjust prices is considered from a bilateral perspective in a setting where changes in outside opportunities drive the incentive to renew contracts and costs preclude continuous renewal. A model encompassing several contract forms is formulated, and the existence of an equilibrium to the bilateral renewal game is established. Prices display inertia, and the incumbent contract is found to be more resistant to changes in outside opportunities, the larger the costs of contract renewal, the variability of outside opportunities and the lower the discount rate. The model is shown to match a number of empirical observations on contracts, and in a macroeconomic application of the model it is shown how nominal inertia may arise and why the rate of inflation and monetary uncertainty have real effects.

JEL Classification: C72, D81, E31

Suggested Citation

Andersen, Torben M. and Christensen, Morten Stampe, Contract Renewal Under Uncertainty (September 1996). Working Paper No. 1997-5. Available at SSRN: https://ssrn.com/abstract=39743 or http://dx.doi.org/10.2139/ssrn.39743

Torben M. Andersen (Contact Author)

University of Aarhus - Department of Economics ( email )

University Park
Building 322
DK-8000 Aarhus C
Denmark
+45 8 942 1609 (Phone)
+45 8 613 6334 (Fax)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Morten Stampe Christensen

University of Aarhus - Department of Economics

University Park
DK-8000 Aarhus C
Denmark

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