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Abstract

This thesis studies the effects of non-Gaussian uncertainty in Economics, in order to explore the richer dynamics that the traditional assumptions of normality cannot provide. The thesis focuses on four key areas of microeconomics: mean-preserving spreads, agency theory, firm investment under uncertainty and firm entry and exit decisions. The first chapter focuses on the riskiness of random variables, and how such risk is perceived by economic agents. We extend Rothschild and Stiglitz’s classical concept of Mean-Preserving Spreads to a dynamic framework, and discover an unique non-Gaussian diffusion process that allows to disentangle risk from variance while maintaining a high degree of analytical tractability. The second chapter studies the formation of optimal contracts under risk sharing, moral hazard and adverse selection in an environment where the agent’s actions control simultaneously the rewards and the riskiness of a general output process. We apply this framework to sharecropping contracts. The third chapter studies how jump-diffusive uncertainty affects firm investment behavior, and shows how jumps depresses the firm’s investment possibilities and how the presence of negative jumps can generate irreversibility even when reversibility is possible. The fourth chapter studies the entry and exit decisions of a firm in an environment driven by a system that preserves memory of past realizations.

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