Assurance contract 2036279 225245995 2008-07-12T17:49:54Z Classicalecon 4831766 '''Assurance contracts''', also known as '''provision point mechanisms''' are a [[Financial engineering|financial technology]] that facilitates the voluntary creation of [[public good]]s and [[Club good]]s in the face of the [[free rider problem]]. The free rider problem is that there may be actions that would benefit a large group of people, but once the action is taken, there is no way to exclude those who did not pay for the action from the benefits. This leads to a [[game theory|game theoretic]] problem: all members of a group might be better off if an action was taken, and the members of the group contributed to the cost of the action, but many members of the group may make the perfectly rational decision to let others pay for it, then reap the benefits for free, possibly with the result that no action is taken. The result of this rational game play is lower [[utility]] for everyone. Assurance contracts operate as follows: In a binding way, members of a group pledge to contribute to action A if a total contribution level is reached (often a monetary threshold, or a quorum of N members making the same pledge). If the threshold level is met (perhaps by a certain expiration date), the action is taken, and the public good is provided; otherwise, the parties are not bound to carry through the action. The binding mechanism may be a contract enforced by a government, a contract enforced by a private organization (e.g. a mediator, a protection agency in an [[Anarcho-capitalism|anarcho-capitalist]] society, etc.), an escrow organization (in such cases, the "binding contract" is "signed" by depositing funds in advance, which are later either disbursed according to the contract, or refunded), etc. ==Political overtones== Assurance contracts are popular with [[libertarians]] and [[anarcho-capitalism|anarcho-capitalists]] as they solve a problem that has usually required governments, and do so in a way that does not involve coercion. ==Variants== Dominant Assurance Contracts, created by [[Alex Tabarrok]], involve an extra component - an entrepreneur creates extra value for signors by paying them if and only if a quorum is not formed; if the quorum is not formed, the signors do not pay their share, and indeed, actually benefit from having participated since they keep the monies the entrepreneur paid them. Similarly, if the quorum succeeds, they return the entrepreneur's monies, and pay a little extra to the entrepreneur for taking the risk of the quorum failing and his money not being returned. So, a player will calculate that whether the quorum fails or not he benefits- if it fails, then he reaps a monetary return, and if it succeeds, he pays only a small amount more under a Dominant Assurance Contract than under an Assurance Contract, plus the public good will be produced. Tabarrok asserts that this creates a [[Dominance (game theory)|dominant strategy]] of participation for all players. Because all players will calculate that it is in their best interests to participate, the contract will succeed, and the entrepreneur will be rewarded. In a meta-game, this reward is an incentive for other entrepreneurs to enter the Dominant Assurance Contract market, driving down the cost disadvantage of Dominant Assurance Contracts versus Assurance Contracts. ==See also== * [[Street performer protocol]] * [[fund and release]] ==External links== *A popular introduction to the theory of assurance contracts (as measured by [[Google]] page- [[blogosphere]]-ranking), was [http://www.marginalrevolution.com/marginalrevolution/2005/05/assurance_contr.html this] post in the [[Marginal Revolution (blog)|Marginal Revolution]] blog. *[http://mason.gmu.edu/~atabarro/PrivateProvision.pdf Tabarrok's paper on Dominant Assurance Contracts] (PDF). *Participation in the [http://freestateproject.org/ Free State Project] is based on an assurance contract. Participants agree to relocate to New Hampshire upon getting pledges from 20,000 other people (by a certain date) to do the same. If not enough people pledge, pledgers are absolved from the requirement to relocate. ===Assurance Contract Websites=== *[http://www.thepoint.com/ ThePoint.com] allows users to create assurance contracts. *[http://www.fundable.org/ Fundable.org] provides an assurance contracts mechanism. *[http://www.pledgebank.com/ Pledgebank.com] is another attempt to set up assurance contracts. *[http://www.pubsoft.org/ Public Software Fund] is another effort at assurance contracts for software improvements. *[http://www.digitalartauction.com/ The Digital Art Auction] is an early attempt to set up assurance contracts, now superseded by a [[contingency market]] called [http://www.contingencymarket.com/ The Contingency Market] - which also supports dominant assurance contracts. [[Category:Structured finance]]