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Hedging, multiple contracting equilibria & nominal contracts

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Why would two risk-average agents write a nominal contract? A possible answer is that for an agent who is subject to risks caused by price variability, a nominal contract that offers hedging against these risks may be optimal. This paper argues that nominal contracts may have a role in efficiency allocating risks that are associated with changes in the price level. These risks may be fundamental to the economy or caused by imperfections. Alternatively they may be caused by the fact that other nominal contracts are written in the economy. As an additional nominal contract is preferred by an agent who has already written a nominal contract, multiple contracting equilibria may exist and nominal contracts can arise as equilibrium phenomena. Therefore this paper identifies advantages to writing nominal contracts in order to efficiently allocate risk but it also points out that under certain restrictions nominal contracts can also lead to inefficient equilibria.

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