Dynamic mechanism design with hidden income and hidden actions

Matthias Doepke, Robert M. Townsend*

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

35 Scopus citations

Abstract

We develop general recursive methods to solve for optimal contracts in dynamic principal-agent environments with hidden states and hidden actions. Starting from a general mechanism with arbitrary communication, randomization, full history dependence, and without restrictions on preferences or technology, we show that the optimal contract can be implemented as a recursive direct mechanism. A curse of dimensionality which arises from the interaction of hidden income and hidden actions can be overcome by introducing utility bounds for behavior off the equilibrium path. Environments with multiple actions are implemented using multiple layers of such off-path utility bounds.

Original languageEnglish (US)
Pages (from-to)235-285
Number of pages51
JournalJournal of Economic Theory
Volume126
Issue number1
DOIs
StatePublished - Jan 2006

Keywords

  • Dynamic contracts
  • Mechanism design
  • Recursive contracts

ASJC Scopus subject areas

  • Economics and Econometrics

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