Christopher Phelan - Consultant
Published March 1, 1999
There is now an extensive literature regarding the efficient design of incentive mechanisms in dynamic environments. In this literature, there are no exogenous links across time periods because either privately observed shocks are assumed time independent or past private actions have no influence on the realizations of current variables. The absence of exogenous links across time periods ensures that preferences over continuation contracts are common knowledge, making the definition of incentive compatible contracts at a point in time a simple matter. In this paper, we present general recursive methods to handle environments where privately observed variables are linked over time. We show that incentive compatible contracts are implemented recursively with a threat keeping constraint in addition to the usual temporary incentive compatibility conditions.
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