Working Paper Abstracts – 1980

01-80
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02-80
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03-80
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04-80
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05-80

In automobile insurance the premium rate which the insured must pay increases whenever he files a claim. Here we present the optimal claims strategy of the insured. It is shown that the insured will file a claim only if the damage exceeds some critical value which depends on his premium rate and on time. We present a method for obtaining the critical values, and investigate some of their properties. We investi-gate the effect of increasing the risk of the damages distribution on the claims policy and on the welfare of the insured (we used Rothschild and Stiglitz’s [1970], and Diamond and Stiglitz’s [1974] definitions of increased risk). Surprisingly, we show that increased risk may improve the welfare of the insured. We also explore the effect of increased current income on the optimal claims policy, and show that such an increase tends to augment the critical values. Further intuitive properties of the optimal claims policy are provided in a numerical example.

06-80
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07-80
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08-80
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09-80
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10-80
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11-80

This study analyzes why formation of an exchange-rate union, such as the newly-established European Monetary System, can be harmful to the interests of some member countries. The framework provided for analyzing behavior in the union is a three-country model which combines an asset market determination of exchange rates with a price sector emphasizing wage indexa-tion behavior and price competitiveness between countries. The three countries consist of two members of the union as well as a nonmember country (the United States), allowing the study to investigate trade and financial relationships within and outside the union.

The study examines how each country’s exchange rates and prices respond to stochastic disturbances of several types, of which the most important is a capital account disturbance directly affecting one member’s financial market (originating, for example, in shifts between U.S. securities and those of one member country). The analysis shows that the effects of the union on each member country depends upon (1) the source of those economic disturbances which give rise to fluctuations in exchange rates, (2) the share of trade between members of the union, (3) the degree of integration between the financial markets of the member countries, and (4) the responsiveness of domestic wages and prices to changes in exchange rates.

The exchange-rate union fixes the cross exchange rate between member currencies, thereby preventing disturbances from affecting this key exchange rate. In doing so, however, the union may actually increase the variability of prices in the economy of one member country. The outcome depends critically upon the degree of financial integration between the two member countries in the absence of the union. The importance of another factor, domestic price responsiveness, is brought out clearly by comparing the alternative extremes of no price adjustment and full price adjustment to exchange rate changes. Price behavior interacts in an interesting way with financial integration to determine the potential gains or losses of each country in joining the union.

12-80
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13-80
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14-80

With incomplete financial markets government debt may be non-neutral even if individuals perceive that the value of the debt is the discounted value of future taxes and there are no opportunities for individuals to shift the tax burden among themselves. Non-neutrality arises because of the effects of a change in future taxation on individuals’ consumption sets. There exists a taxation vector which cannot be defeated by a majority vote of consumers, when these are asked about their preferences as between this taxation vector and any other taxation vector. The equilibrium is non-manipulable and thus stable.

15-80

Most analyses of the principal-agent problem assume that the principal chooses an incentive scheme to maximize expected utility subject to the agent’s utility being at a stationary point. An important paper of Mirrlees has shown that this approach is generally invalid. We present an alternative procedure. If the agent’s utility function is separable in action and reward, we show that the op-timal way of implementing an action by the agent can be found by solving a convex programming problem. We use this to characterize the optimal incentive scheme and to analyze the determinants of the seriousness of an incentive problem.

16-80
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17-80
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18-80
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19-80
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20-80
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21-80
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M1-80
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