Higher Seminar in Economics: Equilibrium Contracts and Boundedly Rational Expectations
Welcome to Higher Seminar in Economics organised by the Department of Economics, SSE. The seminar speaker is Heidi Thysen, LSE/NHH, who will be presenting the paper "Equilibrium Contracts and Boundedly Rational Expectations".
Heidi Thysen, LSE/NHH
"Equilibrium Contracts and Boundedly Rational Expectations", joint with Heiner Schumacher
ABSTRACT: We study a principal-agent framework in which the agent forms beliefs based on a misspecified subjective model of the principal’s project. She fits this model to the objective probability distribution to predict output under alternative actions. Misspecifications in the subjective model may lead to biased beliefs. However, under mild restrictions, the agent has correct beliefs on the equilibrium path so that the optimal contract is non-exploitative. This allows for a behavioral version of the informativeness principle: The optimal contract conditions on an additional variable only if it is informative about the action according to the agent’s subjective model. We further characterize when misspecifications affect the optimal contract. One implication of this characterization is that the scope for belief biases depends on the agent’s job, e.g., her position in the hierarchy.