Choosing between Big-Bang and Gradualist Reforms:
An Option Price
Approach
by Barbara G. Katz and Joel Owen
Off-campus link for NYU students/faculty/staff
Abstract
We derive the exact conditions for choosing between the big-bang strategy and a gradualist package following the model of Dewatripont and Roland (1995, Amer. Econ. Rev. 85, 5:1207-1223). We consider gradualism as an option of early bailout and derive its option price. We show how the option price can be used to select between gradualism and the big-bang strategy, between different gradualist packages, and between the best gradualist package and the big-bang strategy. Our results show that the fundamental proposition of Dewatripont and Roland is incorrect so that we conclude that their case against the big-bang strategy is overstated.