Nie, Y., J. Yang, and Z. Zou

Publication:

Journal of Economic Dynamics and Control

Abstract:

We consider a robust contract with limited commitment in continuous time, in which the principal (firm) is ambiguity averse and seeks robust decisions. First, we find the existence of limited commitment not only attenuates the negative effect of model uncertainty on the firm value, but also makes the firm less pessimistic. Moreover, concerns regarding model misspecification motivate the firm to increase the worker’s exposure to the productivity shocks via the optimal contract. Finally, our theoretical model predicts that the combination of limited commitment and ambiguity generates both right skewness and decreases in the wage dynamics as the empirical data.

[Keywords]Limited commitment, Model uncertainty, Wage dynamics, Risk sharing, Ambiguity sharing

Link: https://www.sciencedirect.com/science/article/pii/S016518892030110X