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0 if not attack
1 if attack
Let denote the mass of agents attacking.
=
Z
a
i
di
The regime can either change 1 = 1, or not change 1 = 0. A regime change in this game is the devaluation
of the currency. Devaluation occurs (1 = 1) if and only if
0 + : + c
Otherwise, there is no regime change, 1 = 0. Here 0 R represents the exogenous underlying economic
fundamentals of the country, : is assistance by the IMF, and c is adjustment eort taken by the domestic
government.
Note that both : and c increase the region of no devaluation, but this will come at a cost. Finally, we say
the regime is viable when 0 + c _ 0.
Payos. Here we describe the payos for (i) the private-sector agents, (ii) the government, and (iii) the IMF.
(i) Agents who attack get payo 1 c. Agents who do not attack get payo
(0, :, ) =
0 if 0 + : + c
1 if _ 0 + : + c
Thus, the payos of an agent may be written as
1 = 1 1 = 0
a
i
= 1 1 c 1 c
a
i
= 0 0 1
1
(ii) The governments payos are given by
(0, :, ) (c)
Thus, there is a cost of adjustment eort.
(iii) The payos for the IMF are given by
): if 0 + c < 0
(0, :, ) ): if 0 + c _ 0
Timing.
1. Nature draws c. This parameter is then common knowledge.
2. The government chooses c. This parameter is then common knowledge.
3. The IMF chooses :. This parameter is then common knowledge.
4. Nature draws 0 ~ A(c, 1,c). This is unobservable.
5. Each agent observes a private signal about 0 given by
r
i
= 0 +
i
with
i
~ A(0, 1,,), i.i.d.
Questions.
(a) Show that for strategic purposes, the agents payo matrix is equivalent to the usual one.
1 = 1 1 = 0
a
i
= 1 1 c c
a
i
= 0 0 0
(b) Given :, c and c, characterize the equilibrium in the last stage of the game. Let r
(c) , 0
. How does 0
depend on : and on c?
(e) Given c, c and the equilibrium in the last stage, state the maximization problem faced by the IMF.
(f) Show that if we assume ) small and take c , the approximate solution is
:
(j) -
8
<
:
0 if j < 0
(1 c) j if 0 _ j _ 1 c
0 if j 1 c
where j = c + c.
2
(g) Given c and your previous answers, state the governments problem in the rst stage. Assume (c) = c
2
.
Solve for the optimal eort choice c as a function of c.
(h) Solve for the optimal choice of eort c as a function of c in a world without IMF assistance (i.e. : = 0).
Compare your answer to part (g). Can adjustment eort be ranked unambiguously across the two regimes?
Interpret your results.
(i) Now assume that the IMF can commit on a function :(c, c). Solve for the IMFs optimal function and
for the governments optimal choice of eort under this commitment. Interpret your results.
(j) Assume (c, :) could be chosen in a centralized way to maximize a weighted average of the payos of the
IMF and the government. Assume weights 1,2 for each and solve for the optimal c and :. Interpret your
results.
3
2 Typicality of Beliefs
There is a measure one continuum of agents, indexed by i [0, 1]. Each agent i chooses whether or not to
invest, a
i
0, 1. Payos are given by
n(a
i
, ) = a
i
(0 + )
where denotes aggregate investment,
=
Z
a
i
di
and 0 is a random variable with support on the real line.
Questions.
(a) Assume 0 is common knowledge and solve for the equilibrium/equilibria.
(b) Now assume 0 is an unknown random variable. Agents observe a private signal r
i
about 0. The agents
system of beliefs is such that for all r
i
E[ 0[ r
i
] = r
i
and for any r
j
,
Pr [ r
j
< r
i
[ r
i
] = Pr [ r
j
r
i
[ r
i
] =
1
2
We interpret this as each agent believes he is typical. Solve for the equilibrium and prove uniqueness.
(c) Now assume the usual Morris Shin system of private and public signals. 0 is an unknown random variable
drawn from an improper uniform over the real line. Each agent observes a private signal
r
i
= 0 + i
i
with i
i
~ A(0, 1,c), i.i.d.
and a exogenous public signal
. = 0 + - with - ~ A(0, 1,,)
Compute the probabilities Pr [ r
j
< r
i
[ r
i
] and Pr [ r
j
r
i
[ r
i
] for arbitrary precisions.
(d) Show that the two probabilities Pr [ r
j
< r
i
[ r
i
] and Pr [ r
j
r
i
[ r
i
] found in part (c) converges to 1,2 for
any (r
i
, .) when the precision of private information goes to innity; that is, c . That is, we generate
typicality of beliefs. Relate this to the uniqueness result found in part (b).
(e) Finally, assume 0 is an unknown random variable and agents observe a private signal r
i
. The agents
system of beliefs is such that for all r
i
E[ 0[ r
i
] = r
i
and for any r
j
,
Pr [ r
j
= r
i
[ r
i
] = `
Pr [ r
j
< r
i
[ r
i
] = Pr [ r
j
r
i
[ r
i
] =
1
2
(1 `)
Show that you can construct two threshold equilibria: one with
r
= `
1
2
(1 `)
and the other with
r
=
1
2
(1 `)
What happens when ` 0? What happens when ` 1? Interpret your results.
4
3 Can better public information crowd out learning?
There is a measure one continuum of agents, indexed by i [0, 1]. There are two stages. An agent i chooses
actions a
1i
in stage 1, and a
2i
in stage 2. His payos are given by
l (a
1i
, a
2i
, a
1
) = (1 r) (a
1i
0)
2
r (a
1i
a
1
)
2
(a
2i
0)
2
where 0 is the underlying fundamental and a
1
=
R
a
1i
d, is the average action in stage 1.
The timing is as follows. First, Nature draws 0 from an (improper) uniform over the real line. In stage 1,
agents observe an exogenous private signal
r
i
= 0 + i
i
with i
i
~ A(0, 1,i
x
) i.i.d.
and an exogenous public signal
j = 0 + - with - ~ A(0, 1,i
y
)
Once agents observe their signals, they choose their actions a
1i
.
In stage 2, agents observe an endogenous public signal about the average action in stage 1
. = a
1
+ n with n ~ A(0, 1,i
u
)
Once agents observe this signal, they choose their action a
2i
.
Thus, the information set of agent i when he chooses a
1i
is .
1i
= r
i
, j, and the information set of agent i
when he chooses a
2i
is .
2i
= r
i
, j, ..
Questions.
(a) Write down the best-response function for a
1i
and solve for the equilibrium in stage 1.
(b) Given your answer to part (a), show that in stage 2, the endogenous public signal . can be transformed
by agents into an unbiased signal of 0
.
0
= 0 + c
0
n
for some c
0
.
(c) Let = c
0
n. Then .
0
= 0+ with ~ A(0, 1,i
z
). Thus, we let i
z
denote the precision of the transformed
signal .
0
. Find i
z
in terms of i
x
, i
y
, i
u
.
(d) Is i
z
increasing or decreasing in i
y
? Is i
z
increasing or decreasing in r? Interpret these results.
(e) Finally, write down the best-response function for a
2i
and solve for the equilibrium in stage 2.
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