Bounded Rationality and Incomplete Contracts
by
Luca Anderlini
Southampton University and Georgetown University
Coauthors: Leonardo Felli (London School of Economics)

This paper explores the link between boundedly rational behavior and incomplete contracts. The bounded rationality of the agents in our world is embodied in a constraint that the contracts they write must be algorithmic in nature.

We start with a definition of contract incompleteness that seems both appealing and widely applicable. Our first task is then to show that, by itself, the algorithmic nature of contracts is not enough to generate genuinely incomplete contracts in equilibrium. As in Anderlini and Felli (QJE, 1994), we call this the approximation result.

We then proceed to consider contractual situations in which the complexity costs of a contract are explicitly taken into account. In this framework we sow that incomplete contracts obtain in equilibrium.

After relating this work to some recent literature, we introduce some preliminary results that may take us away from the approximation result mentioned above. Work in progress by Al-Najjar, Anderlini and Felli (2000) shows that if we allow for contracts that are contingent on some `complex' events, then the restriction to algorithmic contracts alone may be sufficient to generate endogenously incomplete contracts in equilibrium.

Date received: June 7, 2000

Copyright © 2000 by the author(s). The author(s) of this document and the organizers of the conference have granted their consent to include this abstract in Atlas Conferences Inc. Document # cafc-93.