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Recursive contracts
Marcet, Albert; Marimon, Ramon
Universitat Pompeu Fabra. Departament d'Economia i Empresa
We obtain a recursive formulation for a general class of contractingproblems involving incentive constraints. Under these constraints,the corresponding maximization (sup) problems fails to have arecursive solution. Our approach consists of studying the Lagrangian.We show that, under standard assumptions, the solution to theLagrangian is characterized by a recursive saddle point (infsup)functional equation, analogous to Bellman's equation. Our approachapplies to a large class of contractual problems. As examples, westudy the optimal policy in a model with intertemporal participationconstraints (which arise in models of default) and intertemporalcompetitive constraints (which arise in Ramsey equilibria).
2005-09-15
Macroeconomics and International Economics
time inconsistency
recursive formulation
dynamic programming
ramsey equilibrium
participation constraint
recursive saddle points
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