MARTINE QUINZII
Professor of Economics
Theory of Incomplete Markets, MIT Press
Incomplete Markets, Edward Elgar Publishing
Recent
Papers and Current Working Papers
"Common Shocks and Relative Compensation Schemes", with M. Magill, December 2005
Abstract: This paper studies qualitative properties of an optimal contract in a multi-agent setting in which agents are subject to a common shock. We derive a necessary and sufficient condition for the optimal reward of an agent producing an output level y to be a decreasing (increasing) function of the outputs of the other agents, under the assumption that the agents' outputs are informative signals of the value of the common shock. The condition is that the likelihood ratio p(y,e,\eta)/p(y,e',\eta), where e is a higher effort level than e', and \eta is the value of the common shock, be a decreasing (increasing) function of \eta. We derive conditions on the way the common shock affects the marginal product of effort under which the likelihood ratio is decreasing for all output levels, or increasing for some output levels and decreasing for others.
"Normative Properties of Stock Market Equilibrium with Moral Hazard", circulated under the tile "An Equilibrium Model of Managerial Compensation", with M. Magill, Revised November 2005
Abstract: This paper studies a general equilibrium model with two groups of agents, investors (shareholders) and managers of firms, in which managerial effort is not observable and influences the probabilities of firms' outcomes. Shareholders of each firm offer the manager an incentive contract which maximizes the firm's market value, under the assumption that the financial markets are complete relative to the possible outcomes of the firms. The paper studies two sources of inefficiency of equilibrium. First, when investors are risk averse and effort influences probability, market-value maximization differs from maximization of expected utility. Second, because the optimal contract exploits all sources of information for inferring managerial effort, when firms' outputs are correlated the contract of a manager depends on the outcomes of other firms. This leads to an external effect of the effort of one manager on the compensation of other managers, which market-value maximization ignores. We show that under typical conditions these two effects lead to an under-provision of effort in equilibrium. These inefficiencies disappear however if each firm is replicated, and in the limit there is a continuum of firms of each type.
"The Probability Approach to General Equilibrium with Production", with M. Magill, March 2007,Abstract: This paper studies a two-period stochastic economy in which a firm's investment influences the probability distribution of its profit. We take a normative approach asking which criterion firms should maximize to obtain an equilibrium which is Pareto optimal. We find that firms should maximize their contribution to expected social welfare, and that market value maximization typically leads to under investment. We also study the role of prices in conveying the information that firms need to know in order to take optimal investment decisions.
Introduction to Incomplete Markets, Volume 1, with M. Magill, 2007, to be published by Edward Elgar Publishing.
Introduction to Incomplete Markets, Volume 1, with M. Magill, 2007, to be published by Edward Elgar Publishing.
"A Co-Moment Criterion for the Choice of Risky Investment by Firms " , with M. Magill, 2008
Abstract. This paper uses Taylor series expansions and the assumption of small risks to derive a co-moment criterion that firms should maximize so that the resulting equilibrium is Pareto optimal. This is done in two models of production under uncertainty: the state-of-nature SN model in which the firms' outputs depend on states of nature and financial markets are complete with respect to these states of nature; and the probability P model in which the firms' risky outputs are modeled by their joint probabilities and financial markets span the outcome space of the firms. The theoretical criterion in the model is market-value maximization, while in the P model it is maximization of a firm's contribution to social welfare. We show that both criteria can be transformed into a common co-moment criterion which a firm should maximize, taking as given the production decisions of other firms and the co-moment prices, which can be deduced from the security prices. The co-moment criterion provides a unifying framework for the two equilibrium models of production under uncertainty, has the merit of being based on information which is readily available to firms, and provides greater insight than the theoretical criterion into the risk characteristics of its profit stream which a firm should focus on when choosing its investment plan.