Browsing by Author "Wang, XY"

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Open Access
A Note on Moral Hazard and Linear Compensation Schemes
(Economic Research Initiatives at Duke (ERID) Working Paper, 2013-07-18) Wang, XY
This note identifies a moral hazard environment in which a piecewise linear compensation scheme is optimal. Both the principal and the agent have CARA utility, mean output is increasing in the agent's non-contractible input, and output is distributed according to a Laplace distribution, which resembles a normal distribution (e.g. it is symmetric about the mean), but has fatter tails. The key property of the Laplace distribution is that the likelihood ratio is a piecewise constant, where the discontinuity occurs at the mean. The value of this approach is twofold: First, a tractable, empirically-observed wage scheme emerges as the equilibrium in a simple static contracting model. Second, the optimal piecewise linear scheme cleanly separates insurance and incentive provision. The linearity at output levels away from the mean captures insurance, while the jump at the mean captures incentive provision. Hence, this model is well-suited for studying a wide variety of principal-agent problems in risky environments subject to moral hazard, such as the effect of risk and moral hazard considerations on employment relationships in developing economies.
Open Access
Endogenous Insurance and Informal Relationships
(Economic Research Initiatives at Duke (ERID) Working Paper, 2015-02-23) Wang, XY
Heterogeneously risk-averse individuals who lack access to formal insurance build and use relationships with each other to manage risk. I show that the composition of equilibrium relationships under pairwise matching and when group size is endogenous is determined by a mean-variance trade-off across differentially risky productive opportunities, though output distributions may have infinitely-many nonzero cumulants. This has important policy implications. For example, a policy which ignores the equilibrium response of informal institutions may exacerbate inequality and hurt most those it intended to help: a reduction in aggregate risk may lead to an increase in risk borne by the most risk-averse individuals, as the least risk-averse abandon their roles as informal insurers. The theory also sheds light on the channels through which endogenous insurance relationships influence informal firm structure and entrepreneurship.
Open Access
Interdependent Utility and Truthtelling in Two-Sided Matching
(Economic Research Initiatives at Duke (ERID) Working Paper, 2013-07-18) Wang, XY
Mechanisms which implement stable matchings are often observed to work well in practice, even in environments where the stable outcome is not unique, information is complete, and the number of players is small. Why might individuals refrain from strategic manipulation, even when the complexity cost of manipulation is low? I study a two-sided, one-to-one matching problem with no side transfers, where utility is interdependent in the following intuitive sense: an individual's utility from a match depends not only on her preference ranking of her assigned partner, but also on that partner's ranking of her. I show that, in a world of complete information and linear interdependence, a unique stable matching emerges, and is attained by a modified Gale-Shapley deferred acceptance algorithm. As a result, a stable rule supports truth-telling as an equilibrium strategy. Hence, these results offer a new intuition for why stable matching mechanisms seem to work well in practice, despite their theoretic manipulability: individuals may value being liked.