optimal discretionary monetary policy in a model of asymmetric central bank preferences this paper considers optimal monetary policy in the context of the central bank adopting an asymmetric objective function our results show that under asymmetric preferences many of the extant results on the time consistency problem need no longer hold

the variance gamma v g model for share market returns a new stochastic process termed the variance gamma process is proposed as a model for the uncertainty underlying security prices the unit period distribution is normal conditional on a variance that is distributed as a gamma variate its advantages include long tailedness continuous time specification finite moments of all orders elliptical multivariate unit period distributions and good empirical fit the process is pure jump approximable by a compound poisson process with high jump frequency and low jump magnitudes applications to option pricing show differential effects for options on the money compared to in or out of the money copyright 1990 by the university of chicago

can agents be better off with pay caps a popular way to discipline the managers of companies or banks that got into trouble during the recent financial crisis has been to impose caps on managers pay using a small extension of the standard principal agent model we argue that pay caps might serve the opposite purpose because the agent might be better off with a pay cap specifically we show that given a fixed effort level to be implemented the agent s expected utility can be decreasing in an upper bound for the agent s reward the effect of pay caps on the general structure of optimal incentive contracts is also characterized while an improvement of contracting information always helps the principal it might increase or decrease the marginal cost of imposing pay caps

measuring the time inconsistency of us monetary policy this paper offers an alternative explanation for the great inflation of the 1970s by measuring a novel source of monetary policy time inconsistency in the presence of asymmetric preferences the monetary authorities generate a systematic inflation bias through the private sector expectations of a larger policy response in recessions than in booms the estimated fed s implicit target for inflation has declined from the pre to the post volcker regime the average inflation bias was about 1 before 1979 but this has disappeared over the last two decades because the preferences on output stabilization were large and asymmetric only in the former period

optimal design of pro conservation incentives abstract payments for environmental services pes schemes have become an increasingly accepted and popular mode for governmental and non governmental agencies to use in addressing local and regional declines in ecosystem services in pes schemes payments can either be tied to indicators of actions for service provision or to indicators of the generated service itself performance payments are synonymous for this second group i e payments are completely contingent on the procurement of an environmental good or service such a focus raises several practical issues during implementation we review and translate key aspects of the economic theory of incentives into the context of performance payment schemes with special attention paid to two practical issues risks outside the individual s control and distortion in the measurement of environmental services four different incentive payment approaches are presented and the effects of risk and distortion on optimal incentives are discussed the investigation of each payment approach is accompanied by a discussion of examples from the field

are monetary policy reaction functions asymmetric the role of nonlinearity in the phillips curve abstract this paper investigates the implications of a nonlinear phillips curve for the derivation of optimal monetary policy rules combined with a quadratic loss function the optimal policy is also nonlinear with the policy maker increasing interest rates by a larger amount when inflation or output are above target than the amount it will reduce them when they are below target specifically the main prediction of our model is that such a source of nonlinearity leads to the inclusion of the interaction between expected inflation and the output gap in an otherwise linear taylor rule we find empirical support for this type of asymmetries in the interest rate setting behaviour of four european central banks but none for the us fed

leverage decision and manager compensation with choice of effort and volatility abstract we study the incentive effects of granting levered or unlevered stock to a risk averse manager the stock is granted by risk neutral shareholders who choose leverage and compensation level the manager applies costly effort and selects the level of volatility both of which affect expected return the results are driven by the attempt of the risk neutral shareholders to maximize the value of their claims net of the compensation package we consider a dynamic setting and find that levered stock is optimal for high type managers firms with high momentum large firms and firms for which additional volatility only implies a modest increase in expected return

distinguished lecture on economics in government what central bankers could learn from academics and vice versa academic writing about monetary policy has been useful to practical central bankers but more of certain aspects of the economists way of thinking could profitably be imported on the other hand academics could improve their analysis and make it more useful to policymakers if they would pay more attention to certain real world aspects of monetary policy the author draws on his experience at the federal reserve board to point out a number of specific lessons for each side

justifying the first order approach to principal agent problems it is of interest to know when the incentive compatibility conditio n in principal agent problems can be replaced by the condition that the agent s expected utility be stationary in effort the mirrlees rogerson conditions do not work if the principal can observe more than one observable statistic also the mirrlees rogerson assumption that the distribution function of output is convex in the agent s action is unsatisfactory even in the context of the basi c model it is too restrictive the paper presents a suite of conditio ns that are applicable to the multistatistic case and replaces the objectionable convex distribution function assumption copyright 1988 by the econometric society

the provision of incentives in firms i ncentives are the essence of economics despite many wide ranging claims about their supposed importance there has been little empirical assessment of incentive provision for workers the purpose of this paper is to critically overview existing work on the provision of incentives since the interests of workers and their employers are not always aligned a large theoretical literature has emphasized how firms design compensation contracts to induce employees to operate in the firm s interest this literature has reached into many areas of compensation and has pointed to a multitude of different mechanisms that can be used to induce workers to act in the interests of their employers these include piece rates options discretionary bonuses promotions profit sharing efficiency wages deferred compensation and so on my objective here is to evaluate this literature in the light of a growing empirical literature on compensation where possible i will address the literature from two perspectives first an underlying assumption of this literature is that individuals respond to contracts that reward performance accordingly i consider whether agents behave in this way and whether these responses are always in the firm s interest second i address whether firms write contracts with these responses in mind in other words do contracts look like the predictions of the theory incentives are provided to workers

an equilibrium model of asset pricing and moral hazard this article develops an integrated model of asset pricing and moral hazard it is demonstrated that the expected dollar return of a stock is independent of managerial incentives and idiosyncratic risk but the equilibrium price of the stock depends on them thus the expected rate of return is affected by managerial incentives and idiosyncratic risk it is shown however that managerial incentives and idiosyncratic risk affect the expected rate of return through their influence on systematic risk rather than serve as independent risk factors it is also shown that the risk aversion of the principal in the model leads to less emphasis on relative performance evaluation than

performance thresholds in managerial incentive contracts performance thresholds are commonly used in executive compensation contracts we examine the contractual nonlinearity associated with performance thresholds and its incentive implications incorporating a performance threshold into a standard principal agent model of a linear contract we show that pay schemes using a performance threshold are optimal by truncating a linear scheme at poor performance the threshold mitigates agency costs associated with the downside risk of production examining ceo compensation data we find evidence of the role of performance thresholds as a consequence of under threshold performance the tobit estimator is shown to increase pay performance sensitivity notably improving upon the standard ols estimator

the fine structure of asset returns an empirical investigation we investigate the importance of diffusion and jumps in a new model for asset returns in contrast to standard models we allow for jump components displaying finite or infinite activity and variation empirical investigations of time series indicate that index dynamics are devoid of a diffusion component which may be present in the dynamics of individual stocks this leads to the conjecture confirmed on options data that the risk neutral process should be free of a diffusion component we conclude that the statistical and risk neutral processes for equity prices are pure jump processes of infinite activity and finite variation

quota based compensation plans for multiterritory heterogeneous salesforces we compare quota based salesforce compensation plans with the blss plan i e the optimal curvilinear agency theory based compensation plans proposed in basu lal srinivasan and staelin basu a k r lal v srinivasan r staelin 1985 salesforce compensation plans an agency theoretic perspective marketing sci 4 fall 267 291 a quota plan pays a fixed salary which is supplemented by commission income that is a prespecified fraction of the dollar sales that exceed the quota for a salesforce comprised of multiple salespersons territories we consider a basic quota plan where the commission rate and salary remain the same across salespersons however quotas vary across salespersons territories compared to the blss plan that is individually tailored to each salesperson territory the basic quota plan s total nonoptimality in profit has two components i a shapeinduced nonoptimality arising from the fact that the quota based plan does not have the same optimal shape as the curvilinear blss pl

this is what happened to the oil price macroeconomy relationship abstract many of the quarterly oil price increases observed since 1985 are corrections to even bigger oil price decreases the previous quarter when one looks at the net increase in oil prices over the year recent data are consistent with the historical correlation between oil shocks and recessions

does the time consistency problem explain the behavior of inflation in the united states abstract this paper derives the restrictions imposed by barro and gordon s theory of time consistent monetary policy on a bivariate time series model for inflation and unemployment and tests those restrictions using quarterly us data from 1960 through 1997 the results show that the data are consistent with the implications of the theory for the long run behavior of the two variables indicating that the theory can explain the initial rise and subsequent fall of inflation over the past four decades the results also suggest that the theory must be extended to account more fully for the short run dynamics that appear in the data

lose some save some obesity automobile demand and gasoline consumption abstract this paper examines the unexplored link between the prevalence of overweight and obesity and vehicle demand in the united states exploring annual sales data of new passenger vehicles at the model level in 48 u s counties from 1999 to 2005 we find that new vehicles demanded by consumers are less fuel efficient on average as a larger share of people become overweight or obese the ols results show that a 10 percentage point increase in obesity and overweight reduces the average mpg of new vehicles demanded by 1 4 percent an effect requiring a 12 cent increase in gasoline prices to counteract the 2sls results after controlling for possible endogeneity in overweight and obesity prevalence put those two numbers at 5 percent and 54 cent respectively these findings robust to a variety of specifications suggest that policies to reduce overweight and obesity can have additional benefits for energy security and the environment

lower salaries and no options on the optimal structure of executive pay we estimate a standard principal agent model with constant relative risk aversion and lognormal stock prices for a sample of 598 us ceos the model is widely used in the compensation literature but it predicts that almost all of the ceos in our sample should hold no stock options instead ceos should have lower base salaries and receive additional shares in their companies for a typical value of relative risk aversion almost half of the ceos in our sample would be required to purchase additional stock in their companies from their private savings the model predicts contracts that would reduce average compensation costs by 20 while providing the same incentives and the same utility to ceos we investigate a number of extensions and modi cations of the standard model but nd none of them to be satisfactory we conclude that the standard principal agent model typically used in the literature cannot rationalize observed contracts one reason may be that executive pay contracts are suboptimal

aggregation and linearity in the provision of intertemporal incentives we consider the problem of providing incentives over time for an agent with constant absolute risk aversion the optimal compensation scheme is found to be a linear function of a vector of n accounts which count the number of times that each of the n kinds of observable events occurs the number n is independent of the number of time periods so the accounts may entail substantial aggregation in a continuous time version of the problem the agent controls the drift rate of a vector of accounts that is subject to frequent small random fluctuations the solution is as if the problem were the static one in which the agent controls only the mean of a multivariate normal distribution and the principal is constrained to use a linear compensation rule if the principal can observe only coarser linear aggregates such as revenues costs or profits the optimal compensation scheme is then a linear function of those aggregates the combination of exponential utility normal distributions and linear compensation schemes makes computations and comparative statics easy to do as we illustrate we interpret our linearity results as deriving in part from the richness of the agent s strategy space which makes it possible for the agent to undermine and exploit complicated nonlinear functions of the accounting aggregates

the fed s monetary policy rule and u s inflation the case of asymmetric preferences abstract this paper investigates the empirical relevance of a new framework for monetary policy analysis in which the decision makers are allowed but not required to weight differently positive and negative deviations of inflation and output from the target values the estimates of the central bank s euler equation indicate that the preferences of the fed had been asymmetric only before 1979 with the interest rate response to output contractions being larger than the response to output expansions of the same magnitude we show that this asymmetry on output implied an average inflation bias around 1 5 while the implicit inflation target also declined the asymmetric preferences induced inflation bias appears to account for a sizable fraction of the historical decline in the inflation mean

linearity with project selection and controllable diffusion rate in continuous time principal agent problems i extend holmstrom and milgrom s model by allowing the agent to control privately or publicly the diffusion rate process and show that the optimal contract is still linear i discuss the conditions under which conflicts over the choice of diffusion rate do and do not arise as an application i examine project selection problems of a firm conflicts between the manager and investors arise because giving the manager too much incentive to work to increase the profit from ongoing operations can induce him to be too conservative in project selection possibly resulting in optimal contracts with low sensitivities

performance standards and optimal incentives abstract this paper analyzes incentive design when agents effort influences an uncertain output governed by a random process with semi heavy tails we find that the second best incentive contract pays an output increasing but bounded fee with a shape resembling performance standard contracts that pay a fixed salary plus a capped bonus in this contract the pay performance sensitivity around the standard increases decreases with the frequency with which performance is measured and with the kurtosis volatility parameter of the performance probability distribution we also find that the optimal maximum bonus increases with volatility but decreases with the kurtosis parameter of the performance distribution

introducing convexity into optimal compensation contracts abstract we study when it is appropriate to add a convex component such as stock options to an optimal managerial compensation contract we show that convexity is introduced when managers have moderate levels of relative risk aversion and decreasing absolute risk aversion in addition we study how convexity is affected as the distribution of outcomes becomes more skewed toward low outcomes here we show that while convexity increases when skewness is increased without regard to the effect on mean stock price the opposite effect results when increases in skewness leave the mean stock price unchanged

earnings management the shapes of the frequency distributions of earnings metrics are not evidence ipso facto we provide evidence that the shapes particularly around zero of the frequency distributions of earnings metrics examined in the extant earnings management literature are affected by 1 deflation using for example price or market capitalization 2 sample selection criteria that lead to differential inclusion exclusion of observations to the left of zero versus observations to the right of zero implicit in studies focusing on firms followed by i b e s and explicit in studies partitioning on a variable differing between loss observations and profit observations 3 differences between the characteristics of observations to the left of zero and observations to the right of zero such as market pricing and analyst optimism pessimism or 4 a combination of these factors since the shapes of the frequency distributions of earnings metrics at zero are likely due to one of the above effects we conclude that the shapes cannot be used as ipso facto evidence of earnings management