Unformatted text preview: 3. [35 points] Consider the following variation of Thomas and Worrall (1990). Instead of private information of the household±s endowment, assume the household has a constant income y but he is subjected to ²taste shocks± . Formally, his per-period utility from con-sumption is ±u ( c ) , where u is strictly increasing and strictly concave and ± 2 f ± ‘ ; ± h g , where Pr f ± = ± ‘ g = ² 2 (0 ; 1) . (a) Set up the Bellman equation for the optimal contract problem with in&nite horizon. Derive the &rst-order conditions. (b) Suppose there are two periods only and u ( c ) = ln c . Characterize the optimal contract in this case as fully as possible. 4. [25 points] Solve exercise 21.5 in Ljungqvist and Sargent (2nd edition). 1...
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- Spring '10
- Recursion, Order theory, Mathematical finance, Convex function, one-sided commitment