Bank Monitoring Incentives and Optimal Abs

Pagès, Henri

doi:10.2139/ssrn.2057521

Cited by 13 publications

(11 citation statements)

References 56 publications

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“…We are now ready to give the value function of the investor on the upper boundary of the credible set. In the last region of the upper boundary, in which both the good and the bad agent are monitoring all the loans, it coincides with the value function of the sub-problem 7 studied in [50], denoted by v b j . For the sake of presentation, we recall the results of [50] in Appendix E.1.…”

Section: Value Function Of the Investormentioning

confidence: 67%

“…In the sequel, we will start by deriving the optimal contract in the pure moral hazard case, then we will look into the socalled optimal shutdown contract, for which the investor deliberately excludes the bad bank, before finally investigating the optimal screening contract. We will invoke some results from [50] in this paper, for this reason we will require later the assumptions of their main result, Theorem 3.15, which are the following.…”

Section: Formulation Of the Investor's Problemmentioning

confidence: 99%

“…A second important point in the model is the liquidation policy of the contract. Even though liquidations are inefficient in the first-best situation without moral hazard nor adverse selection (see [50]), they are necessary in the second-best in order to restore incentives to monitor when performance is poor. However, liquidation can take many forms, and for instance liquidating all loans with state-dependent probability is not necessarily better than partially liquidating the pool with fixed probability.…”

Section: Comments On the Modelling Choices And Assumptionsmentioning

confidence: 99%

“…Given that in practice liquidations are rarely decided in such a random fashion, it is of the utmost importance to verify that such liquidation policies cannot improve on social welfare. In the case of pure moral hazard, [50,Proposition 6] has shown that stochastic liquidation was optimal among all policies under an assumption which is met if changes in default intensities for the loans are gradual. Since the capital structure of subprime mortgage-backed securities is typically split up into a large number of tranches, where it is then reasonable to assume that default intensities are constant, such an assumption will be verified in the real-world applications of the model.…”

Section: Comments On the Modelling Choices And Assumptionsmentioning

confidence: 99%

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mentioning

confidence: 99%

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Bank Monitoring Incentives Under Moral Hazard and Adverse Selection

Santibáñez

Possamaï

Zhou

2019

J Optim Theory Appl

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In this paper, we extend the optimal securitisation model of Pagès [50] and Possamaï and Pagès [51] between an investor and a bank to a setting allowing both moral hazard and adverse selection. Following the recent approach to these problems of Cvitanić, Wan and Yang [14], we characterise explicitly and rigorously the so-called credible set of the continuation and temptation values of the bank, and obtain the value function of the investor as well as the optimal contracts through a recursive system of first-order variational inequalities with gradient constraints. We provide a detailed discussion of the properties of the optimal menu of contracts.Principal-Agent problems with moral hazard have an extremely rich history, dating back to the early static models of the 70s, see among many others Zeckhauser [68], Spence and Zeckhauser [63], or Mirrlees [42,43,44,45], as well as the seminal papers by Grossman and Hart [26], Jewitt, [33], Holmström [30] or Rogerson [57]. If moral hazard results from the inability of the Principal to monitor, or to contract upon, the actions of the Agent, there is a second fundamental feature of the Principal-Agent relationship which has been very frequently studied in the literature, namely that of adverse selection, corresponding to the inability to observe private information of the Agent, which is often referred to as his type. In this case, the Principal offers to the Agent a menu of contracts, each having been designed for a specific type. The so-called revelation principle, states then that it is always optimal for the Principal to propose menus for which it is optimal for the Agent to truthfully reveal his type. Pioneering research in the latter direction were due to Mirrlees [46], Mussa and Rosen [47], Roberts [55], Spence [62], Baron and Myerson [7], Maskin and Riley [38], Guesnerie and Laffont [27], and later by Salanié [59], Wilson [67], or Rochet and Choné [56]. However, despite the early realisation of the importance of considering models involving both these features at the same time, the literature on Principal-Agent problems involving both moral hazard and adverse selection has remained, in comparison, rather scarce. As far as we know, they were considered for the first time by Antle [2], in the context of auditor contracts, and then, under the name of generalised Principal-Agent problems, by Myerson [48] 1 . These generalised agency problems were then studied in a wide variety of economic settings, notably by Dionne and Lasserre [17], Laffont and Tirole [35], McAfee and McMillan [39], Picard [54], Baron and Besanko [4, 5], Melumad and Reichelstein [40, 41], Guesnerie, Picard and Rey [28], Page [49], Zou [69], Caillaud, Guesnerie and Rey [10], Lewis and Sappington [36], or Bhattacharyya [8] 2 .All the previously mentioned models are either in static or discrete-time settings. The first study of the continuous time problem with moral hazard and adverse selection was made by Sung [64], in which the author extends the seminal finite horizon and continuous-time model of Hol...

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Section: Value Function Of the Investormentioning

confidence: 67%

Section: Formulation Of the Investor's Problemmentioning

confidence: 99%

Section: Comments On the Modelling Choices And Assumptionsmentioning

confidence: 99%

Section: Comments On the Modelling Choices And Assumptionsmentioning

confidence: 99%

“…

…”

mentioning

confidence: 99%

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Bank Monitoring Incentives Under Moral Hazard and Adverse Selection

Santibáñez

Possamaï

Zhou

2019

J Optim Theory Appl

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Moral Hazard Under Ambiguity

Mastrolia

Possamaï

2018

J Optim Theory Appl

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In this paper, we extend the Holmström and Milgrom problem [47] by adding uncertainty about the volatility of the output for both the Agent and the Principal. We study more precisely the impact of the "Nature" playing against the Agent and the Principal by choosing the worst possible volatility of the output. We solve the first-best and the second-best problems associated with this framework and we show that optimal contracts are in a class of contracts similar to [14,15], linear with respect to the output and its quadratic variation. We compare our results with the classical problem in [47].to designing optimal incentives, and are therefore present in a very large number of situations. Beyond the obvious application to the optimal remuneration of an employee, one can for instance think on how regulators with imperfect information and limited policy instruments can motivate banks to operate entirely in the social interest, on how a company can optimally compensate its executives, on how banks achieve optimal securitisation of mortgage loans or on how investors should pay their portfolio managers (see Bolton and Dewatripont [6] or Laffont and Martimort [49] for many more examples).Early studies of the risk-sharing problem can be found, among others, in Borch [7], Wilson [99] or Ross [78]. Since then, a large literature has emerged, solving very general risk-sharing problems, for instance in a framework with several Agents and recursive utilities (see Duffie et al. [25] or Dumas et al. [26], or for studying optimal compensation of portfolio managers (see or Cadenillas et al. [11]). From the mathematical point of view, these problems can usually be tackled using either their dual formulation or the so-called stochastic maximum principle, which can characterize the optimal choices of the Principal and the Agent through coupled systems of Forward Backward Stochastic Differential Equations (FBSDEs in the sequel) (see the very nice monograph [20] by Cvitanić and Zhang for a systematic presentation). One of the main findings in almost all of these works, is that one can find an optimal contract which is linear in the terminal value of the output managed by the Agent (a result already obtained in [78]) and possibly some benchmark to which his performance is compared. In specific cases, one can even have Markovian optimal contracts which are given as a (possibly linear) functional of the terminal value of the output (see in particular [11] for details).Concerning the so-called moral hazard problem, the first paper on continuous-time Principal-Agent problems is the seminal paper by Holmström and Milgrom [47]. They consider a Principal and an Agent with exponential utility functions and find that the optimal contract is linear. Their work was generalized by Schättler and Sung [83,84], Sung [90,91], Müller [54,55], and Hellwig and Schmidt [46], using a dynamic programming and martingales approach, which is classical in stochastic control theory (see also the survey paper by Sung [92] for more references). The papers by Wi...

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Securitisation and the global financial crisis: can risk retention prevent another crisis?

Senarath

2017

IJBG

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Prima facie securitization played a prominent role in the recent global financial crisis. Moral hazard associated with securitization is the key element behind the failure of securitization. Risk retention is the U.S legislator's response to address the moral hazard issue associated with the originate-to-distribute model. This paper adopts a lexieconomic framework to analyse the risk retention provisions of the Dodd-Frank Act and proves that said provisions are not capable of eliminating moral hazard associated with securitization. This paper argues that in order to ensure proper screening of the borrower, the cost for the lender for not engaging in proper screening and monitoring should be higher than the benefits she gains by not screening. Inter alia this paper further argues that the inclusion of non-recourse mortgages would make securitization schemes susceptible to changes in home prices.

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Bank Monitoring Incentives and Optimal Abs

Cited by 13 publications

References 56 publications

Bank Monitoring Incentives Under Moral Hazard and Adverse Selection

Bank Monitoring Incentives Under Moral Hazard and Adverse Selection

Moral Hazard Under Ambiguity

Securitisation and the global financial crisis: can risk retention prevent another crisis?

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