Working Paper No. 06-04

Demand for Contract Enforcement and Gains from Trade
Anna Rubinchik-Pessach and Roberto M. Samaniego
December 2005


We develop a dynamic exchange environment to analyze the value created by contracting institutions. In the model, a contract is a pre-agreed specification of behavior, which may be subsequently enforced by a third party. We study the effect of economic fundamentals on the demand for such an enforcement agency. We show that this demand may exist even when contracts are sometimes broken in equilibrium, and ask whether this demand is increasing in the potential gains from exchange. Surprisingly, this is not always the case - indeed, if the gains are sufficiently large, the demand may drop to zero. We identify the discount factor and the quality of enforcement as crucial factors behind this relationship.

JEL classification: H11, H41, K42, 017
Keywords: Contracting institutions, third party enforcement, demand for contracts, gains from trade