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Memory in contracts. The experience of the EBRD (1991-2003)

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  • Memory
  • Contract
  • Banking
  • Business & Economic Sciences :: Special Economic Topics (Health
  • Labor
  • Transportation…) [B16]
  • Sciences économiques & De Gestion :: Domaines Particuliers De L'économie (Santé
  • Travail
  • Transport…) [B16]


Memory in Contracts: The Experience of the EBRD (1991-2003) Lionel Artige�- Rosella Nicoliniyz March 2008 Abstract The objective of this paper is to identify the role of memory in repeated contracts with moral hazard in nancial intermediation. We use an original dataset from the European Bank for Recon- struction and Development to test a basic model with repeated moral hazard. To capture the role of memory, we need to control for the adverse selection e¤ect. We propose a simple empirical method to achieve it. Our results unambiguously isolate the e¤ect of memory on the bank s lending decisions. Keywords: Financial Contract; Empirical contract theory; Memory; Moral hazard JEL Classi cation: D21, D82, G21, L14, P21. �HEC-Department of Economics, Université de Liège. E-mail: [email protected] yCorresponding author: Institut d Anàlisi Econòmica - CSIC, Campus de la Universitat Autònoma de Barcelona, 08193 Bellaterra (Barcelona), Spain. E-mail: [email protected] zWe are grateful to Ramon Caminal, Ivan Fernandez Val, Inés Macho-Stadler and Martin Raiser for useful suggestions and discussions. Part of this research has been conducted while the second author was visiting the Department of Economics at Boston University. Any remaining errors are our own responsibility. R. Nicolini s research is supported by Ramón y Cajal and by Barcelona Economics Program of XREA. Financial support from research grants 2005SGR00470 and SEJ2005- 01427/ECON is acknowledged. 1 1 Introduction The optimal long-term contract in repeated moral hazard generally exhibits memory (Lambert 1983, Rogerson 1985 and Chiappori et al. 1994). The decisions made by the agent and the principal in the current period depend on past outcomes. With repeated contracts the principal is able to learn from the agent s past history and, hence, propose a long-term contract that internalizes this information over time. The bene t is that risk sharing across time is improved. A natural applicati

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