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.
Anchoring Expectations of Inflation, with M. Magill, 2011
Abstract. This paper provides a theoretical framework for studying how monetary policy can be used to control expectations of inflation. We consider a simple production economy with a cash-in-advance constraint in which monetary-fiscal policy is Ricardian. Agents' expectations are modeled as probability distributions on a finite set of possible inflation rates. The monetary authority announces a public forecast of inflation to direct agents' expectations, and a bond pricing (term structure of interest rates) policy to make the forecast credible. We study conditions under which an announced forecast is compatible with equilibrium---there must be enough weight on inflation to be compatible with a non-negative nominal interest rate. In a stationary setting we exhibit a rank condition on the payoff structure of the bonds which must be satisfied if the forecast is to be the unique probability distribution compatible with the bond pricing policy, thereby eliminating any other possible expectations of inflation for the agents. The model thus provides a formal framework for understanding the conditions under which the policy of inflation targeting can be successful.
A Theoretical Foundation for the Stakeholder Corporation, with M. Magill and J.C. Rochet, 2011 (circulated under the title Reforming Capitalism)
This paper presents a model of the \textit{stakeholder} corporation and analyzes the equilibrium of an economy with stakeholder firms. The analysis is based on a model of a production economy that differs from the standard approach based on states of nature. The property that differentiates it from the standard model (which justifies the \textit{shareholder} approach to the corporation) is that firms' choices of investment influence the probability distributions of their outputs, and hence exert external effects on consumers and employees: as a result profit maximization and competitive behavior do not lead to Pareto optimality. Using a Coasian approach to resolve the problem of externalities, we show that if firms issue not only equity shares but also marketable property rights for employees and consumers, and if firms' managers maximize the total values of their firms (shareholder value plus consumer and employee values) then Pareto optimality of equilibrium is restored when agents are identical. In the more realistic case where agents are heterogeneous, reforming capitalism by giving some weight to employee and consumer surpluses in the objective of the firms
always increases social welfare.
Interest Rate Policy and Expectations of Inflation, with M. Magill, 2012.
This paper studies a simple monetary model with a Ricardian fiscal policy in which equilibria are indeterminate if monetary policy consists solely of a rule for fixing the short-term interest rate. We introduce explicitly into the model the agents' expectations of inflation which create the indeterminacy and show that there are two types of policies---a term-structure rule or a forward-guidance rule for the short rate---which can lead to determinacy. The first consists in fixing the interest rates on a family of bonds of different maturities as function of realized inflation; the second consists in fixing the short-term interest rate and the expected values of the short-term interest rate for a sequence of periods into the future as a function of realized inflation. If the monetary authority chooses an inflation process which satisfies conditions derived in the paper and applies one of these rules, it can anchor agents' expectations to this process, in the sense that it is the unique inflation process compatible with equilibrium when the interest rates or expected future values of the short rate are those specified by the term-structure or forward-guidance rule.