Information and Incentives in Dynamic Games

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Mathematical economics provides rigorous models and powerful analytical tools for studying a wide range of important and fundamental economic issues. This project emphasizes some of most active areas of research in mathematical economics, namely work on the roles played by information and incentives in dynamic bargaining among economic agents. The project consists of three parts. The first part explores the idea that equilibrium in games might arise as the result of the players learning from thir previous play. This new approach does not model the learning process as part of an equilibrium, but rather assumes that the players use different sorts of "reasonable" behavioal rules. One question given special attention is the relationship between restrictions on these behavioral rules and various sorts of euilibrium refinements. The second part generalizes single player studies of reputation-effects. Previous research found the reputation effects particularly powerful when only a single player has an incentive to maintain a reputation. The single player is able to pick out the equilibrium he most prefers through maintaining a reputation. The third part studies the nature of the optimal contract between a risk-neutral principal and a risk-averse agent when the agent's action is subject to moral hazard and the parties are free to renegotiate the contract after the agent has performed his duties but before all the effects of the agent's actions have been revealed. The objective of this part of the project is to learn how the constraint to renegotiation-proof contracts limits the amount of risk that the agent can be forced to bear, and the amount of effort that the agent can be induced to provide. This project makes methodological and substantive contributions to our understanding of information and incentives in the dynamics of economic games. Methodologically, the project develops a new approach to dynamic games that allows the analyst to derive and not just assume the beliefs of the participants in the games. The traditional approach obtains solutions to dynamic games by making "plausible" assumptions about the beliefs of players. These assumptions are called equilibrium refinements. Unfortunately, game-theoretic models usually can not be tested because there are many different plausible assumptions about player beliefs, each with a different outcome; hence, this new approach moves us closer to the goal of a testable dynamic game theory. Substantively, the project provides new insights into the incentives of economic agents to obtain and maintain reputations. Contract theory is extended to permit the study of the optimal contract for settings in which there is a long gap between the time the agent's actions are undertaken and the time their effects are realized and where in the interim there is the possibility of renegotiation.