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CEP discussion paper
Recursive Contracts
Albert Marcet and Ramon Marimon
June 2011
Paper No' CEPDP1055:
Full Paper (pdf)

JEL Classification: D80; L14

Tags: transactional relationships; contracts and reputation; recursive formulation; participation constraint

We obtain a recursive formulation for a general class of contracting problems involving incentive constraints. These constraints make the corresponding maximization (sup) problems non recursive. Our approach consists of studying a recursive Lagrangian. Under standard general conditions, there is a recursive saddle-point (infsup) functional equation (analogous to a Bellman equation) that characterizes the recursive solution to the planner's problem and forward-looking constraints. Our approach has been applied to a large class of dynamic contractual problems, such as contracts with limited enforcement, optimal policy design with implementability constraints, and dynamic political economy models.