the welfare implications of moral hazard and adverse selection in competitive insurance markets i model a competitive insurance market with both moral hazard and adverse selection and analyze the effect on welfare when both problems are present simultaneously an examination of the interaction between these two problems leads to two hypotheses first the nature of the equilibrium contracts is such that each problem partially offsets the welfare loss associated with the other and second the degree to which this occurs increases as agents become more heterogeneous simulation results overwhelmingly support both hypotheses

a survey of agency models of organizations abstract in recent years neoclassical economists have begun to turn their attention to issues of firm organization stimulated in large part by methodological advances in the economics of incentives and incomplete information the paradigm on which much of this work is based views an organization as an agency relationship agency models incorporate two basic features of organizations incomplete information and goal conflict among members of the organization this essay characterizes and critiques the existing research on agency models of organizations in order to broaden the set of consumers of such models and to stimulate the production of new research

does asymmetric information matter in the early insurance market evidence from the auto insurance market in the late 1960s the performance of automobile insurance declined dramatically in japan in spite of rapid growth in the diffusion rate and the premiums were sharply raised several times in order to improve the situation this observation indicates the possible presence of adverse selection death spiral and provides an ideal situation for assessing informational asymmetry using bodily injury liability bil insurance data from 46 japanese prefectures over the period 1966 to 1975 this article tests two hypotheses of adverse selection i high risk drivers were more likely to join the bil insurance market and ii sharp premium increases drove low risk policyholders away various empirical analyses show that there is little evidence for either type of adverse selection we also test whether a risk misperception hypothesis can explain our results and find some evidence that the population density have a significantly positive impact on the demand for bil insurance an earlier version of this artic

an expected indemnity approach to the measurement of moral hazard in crop insurance a definition of moral hazard in multiple peril crop insurance is proposed that focuses on expected indemnities rather than input use five years of production and insurance data for a panel of kansas wheat farms is used to empirically test for this type of moral hazard results suggest that moral hazard affects multiple peril crop insurance indemnities in poor production years but that no significant moral hazard occurs in years when growing conditions are favorable

adverse selection repeated insurance contracts and announcement strategy in this note we present a strategy which relies on multi period contracts and on a self selection mechanism which induces the insured to announce his true risk in the first period thus eliminating inefficiency due to adverse selection

market equilibrium with private knowledge the effect of asymmetric information between buyers and sellers on product quality was first explored by akerlof 1970 in his pathbreaking paper on the market for lemons he showed that if all purchasers have imperfect information on quality then a market for the product may not exist or if it does function it may not be efficient these results have led to a number of papers concerning insurance and labor markets under different assumptions regarding how agents discriminate between products of varying quality see pauly 1974 rothschild and stiglitz 1976 wilson 1977 miyasaki 1977 and spence 1978

analytical approximations in models of hysteresis decisions made under ongoing uncertainty and costly reversibility entail a range of the state variable where inaction is optimal which in turn produces hysteresis permanent effects of temporary shifts the range is usually defined by non linear equations that need numerical solutions in this paper a technique of analytical approximations is developed and applied to two models menu costs and investment the resulting explicit solutions help clarify why hysteresis is important even for small irreversibility in the menu cost model hysteresis is two orders of magnitude larger than under the akerlof yellen or mankiw assumptions when decisions that are costly to reverse are made under conditions of ongoing uncertainty the optimum policy usually entails a range of inertia the action should be taken only when the value of the underlying state variable becomes especially favourable and reversed only when it becomes especially unfavourable there is an intermediate range over which inaction is optimal this in turn gives rise to hysteresis starting from a value in the range of inertia if the state variable crosses the action trigger point and then returns to its original level the action will be taken but not reversed thus a temporary change will leave a permanent effect numerical solutions for models of irreversible investment show that the range of inaction is remarkably large even when the cost of reversal is small see brennan and schwartz 1985 constantinides 1986 and dixit 1989a b for examples of this unfortunately the equations tlhat determine the optimum policy are highly non linear they do not have analytical solutions therefore we lack a clearer and more general understanding of why hysteresis is numerically so important in this paper i derive analytical approximations for the solutions of more general problems of this kind when the costs of change are small the idea that small costs of change induce large amounts of inertia has been popularized in the model of akerlof and yellen 1985 mankiw 1985 and others in these models second order small costs of making price changes yield price stickiness in response to first order changes in the money supply this is a simple application of the envelope theorem but these models are static and their application to a dynamic reality must assume either permanent shocks or static expectations when there is ongoing uncertainty which is rationally expected by the decision maker the option value of the status quo enlarges the zone where inaction is optimal adding these features to the mankiw akerlof yellen may model i show that fourth order small costs of change generate first order inertia

multi period insurance contracts this paper examines the form of insurance contracts in the presence of asymmetric information about consumers accident probabilities our goal is to understand the adjustment in contract terms as a function of accident histories in a finite horizon model we also compare these adjustments between alternative market structures our principal findings indicate that history dependent insurance contracts serve a useful sorting role individuals who declare themselves low risks to insurance companies face adverse contracturai terms if they subsequently have many accidents these adjustments are strongest in the case of a single insurance seller but are present in the competitive model as well

returns to individual traders of futures aggregate results by means of a data set previously unavailable for academic research actual trading histories of individual futures traders are examined with this more detailed data the author is able to 1 test the risk return hypothesis directly 2 include a much larger segment of the market than before and 3 use actual instead of hypothetical t rading strategies it is shown that the commercial hedging traders are most profitable while noncommercial speculative traders earn n egative or zero profits because speculators are not receiving reward s for the risks they willingly absorb the theory of normal backwarda tion and its extension can be rejected copyright 1987 by university of chicago press

a century of research on agricultural markets this article provides a perspective on major innovations in research on agricultural markets over the past century we review research on market structure and performance vertical coordination arrangements and institutions for producer collective action contributions to empirical modeling of agricultural price determination and marketing margins are also evaluated as are innovations in research on spatial market relationships and the role of storage finally we discuss contributions to understanding market information systems and the functioning of market based mechanisms for agri

financial intermediation delegated monitoring and long term relationships abstract this paper considers the consequences of enduring relationships for bank structure and policy in an information based banking model adding a richer time dimension allows repeated lending between the intermediary and borrower this contract lets a bank produce information and enforce compliance more easily than direct monitoring of the borrower s organization this implies an asymmetric banking structure banks enter long term relationships with borrowers but not with depositors next it shows how enduring relationships solve problems with loan participations and security underwriting by commercial banks

can group incentives alleviate moral hazard the role of pro social preferences abstract incentivizing unobservable effort in risky environments such as in insurance credit and labor markets is vital as moral hazard may otherwise cause significant welfare losses including the outright failure of markets ensuring incentive compatibility through state contingent contracts between principal and agent however is undesirable for risk averse agents we provide a theoretical intuition on how pro social preferences between agents in a joint liability group contract can ensure incentive compatibility two independent large scale behavioral experiments framed in an insurance context support the hypotheses derived from our theory in particular effort decreases when making agents payoff less state dependent but this effect is mitigated with joint liability in a group scheme where agents are additionally motivated by pro social concerns activating strategic motives slightly increases effort further particularly in non anonymous groups with high network strength the results support existing evidence on joint liability groups and further suggest that even if peer pressure to ensure effort provision is absent such group policies can improve efficiency when agents are pro social

toward a positive economic theory of hedging the hedging models developed over the last half century are evaluated for their ability to explain the actual hedging behavior of the various economic agents this evaluation shows a total lack of a reasonable positive model of hedging behavior while each class of existing models predicts some observed behavior none is able to predict the broad range of actions that is easily observed in the real world in this paper i develop such a model and include a plausible and coldly rational economic explanation for why farmers don t hedge at all while merchandisers with identical risk attitudes will fully hedge

incentives in principal agent relationships this article identifies some of the major issues that have been examined in the literature on incentives the article begins by discussing the frictions that lie at the heart of incentive problems next the principal s optimal response to these frictions is explored taking as given the characteristics of the agents with whom the principal interacts in a nonrepeated setting the design of individualized contracts contests and tournaments is analyzed then the principal s task of selecting the best agent is addressed and repeated agency relationships are considered

an intertemporal model of warranties using a simple two period model this paper attempts to explain certaini interesting intertemporal properties of product warranties specifically why does coverage generally fall over time and why is the typical warranty s life so much shorter than the expected life of the product it covers we view warranties as a partial solution to the double moral hazard problem that arises when buyers cannot readily observe the quality built into a product and sellers cannot observe the care with which buyers use it the optimal warranty strikes the right balance between providing incentives for seller quality and for buyer care under certain conditions a two period warranty will render even the first best i e full information solution achievable un modlde intertemporel dce garanties ce memoire tente d expliquer certaines proprietes intertemporelles interessantes des garanties sur les produits a l aide d un modele simple sur deux periodes specifiquement on se pose les questions suivantes pourquoi est ce que generalement la couverture diminue avec le passage du temps et pourquoi la vie de la garantie est elle tellement plus courte que celle du produit auquel elle est attachee les garanties sont perques comme une solution partielle a un double probleme de risque

price discrimination by a many product firm determining the optimal selling strategy for a multiproduct firm facing consumers with unknown tastes is a difficult task this paper aims to show how almost optimal nonlinear tariffs can often be found when the number of products becomes large

insurance moral hazard and chemical use in agriculture this paper examines how crop insurance affects corn farmers fertilizer and pesticide use in the u s midwest crop insurance might be expected to affect chemical use because of moral hazard insured farmers may undertake riskier production than do uninsured farmers results suggest that insurance exerts considerable influence on corn farmers chemical use decisions those purchasing insurance applied significantly more nitrogen per acre 19 spent more on pesticides 21 and treated more acreage with both herbicides and insecticides 7 and 63 than did those not purchasing insurance these results suggest that both fertilizer and pesticides may be risk increasing inputs

self selection and monitoring in dynamic incentive problems with incomplete contracts a dynamic trading problem is examined in which a monopsonistic employer tries to hire workers whose productivities and reservation wages are private information the employer can only observe an employee s quality indirectly by monitoring a non verifiable measure of on the job performance the employer makes contract offers which employees can accept or reject once a contract has been accepted it is impossible for the employer to exchange messages with individual employees on the unique stationary equilibrium path for the contracting game the employer chooses between two mutually exclusive outcomes in the market outcome the employer offers long term contracts and information is conveyed entirely through self selection and delayed production in the monitoring outcome the employer offers short term contracts and contract renegotiation is conditioned by an employee s past performance a simple characterization theorem is provided which illustrates the often surprising effects of improvements in information in this setting for example an employer who is initially offering short term contracts to exploit performance information may stop monitoring and shift to market screening when the monitoring technology becomes more informative

moral hazard cycles in individual coverage crop insurance this paper examines the moral hazard implications of individual coverage crop insurance contracts individual coverage contracts are informationally superior to standard contracts because the farmer s coverage is proportional to his average historical yield despite this apparent benefit the steady state solution is shown to be characterized by moral hazard cycles where moral hazard is practiced in alternative periods the amplitude of the cycle and thus the variability in planned production is shown to be larger the lower the degree of production uncertainty the fewer the number of years used in the averaging process the higher the coverage threshold and the lower the level of co insurance

market volatility and the dynamic hedging of multi commodity price risk commodity cash and futures prices experienced a severe boom and bust cycle between 2006 and 2009 increases in commodity price volatility have raised concerns about the usefulness of commodity futures and options as risk management tools dynamic hedging strategies have the potential to improve risk management when conditional co variances depart significantly from their unconditional long run counterparts and may be useful to decision makers despite their greater complexity and higher transaction costs we propose a nonparametric copula based generalized autoregressive conditional heteroscedastic npc garch approach to estimate time varying hedge ratios and evaluate the benefits of dynamic hedging during four sub periods between 2000 and 2011 using a stylized texas cattle feedlot management problem the npc garch approach allows for a flexible nonlinear and asymmetric dependence structure between cash and futures prices for different commodities we find that npc garch dynamic hedging performs bette

optimal multiperiod contracts and the gain from enduring relationships under private information informational asymmetries can play a key role in explaining the existence and nature of multiperiod contracts in an illustrative risk sharing model even relatively short two period contracts can be mutually beneficial if there is private information though one period contracts suffice otherwise further contracts which are pareto optimal relative to the environment and the information structure are defined and partially characterized an example illustrates how otherwise inefficient intertemporal tie ins can be used optimally to mitigate incentive problems the obvious borrowing lending schemes are not private information pareto optimal in these period by period actions are not sufficiently constrained discounting affects the form of the optimal contract but none of these qualitative conclusions

moral hazard and secured lending in an infinitely repeated credit market game we analyze repeated moral hazard with discounting in a competitive credit market with risk neutrality even without learning or risk aversion long term bank borrower relationships are welfare enhancing the main result is that the borrower obtains an infinite sequence of unsecured loans at below spot market cost following the first good project realization this contract produces first best action choices prior to this stage the borrower gets secured loans with above market borrowing cost the optimal contract thus displays a selective memory feature taking only one of two forms at any given point in time depending on prior history we consider an infinitely repeated bank borrower relationship with moral hazard and universal risk neutrality and explore the ramifications of credit contract duration when the two well known benefits of long term contracting learning and improved risk sharing are absent our objectives are twofold the first is to analyze an infinitely repeated game with discounting in a credit market context we thus relate the theory of repeated games to financial intermediation theory particularly to issues of moral hazard and collateral related distortions the second objective is to understand noteworthy stylized facts of credit markets such as durability in credit relationships lower borrowing costs for established borrowers and unsecured loans for established borrowers versus secured loans for newer borrowers while these practices may be partly due to learning we show that learning is not essential to rationalize them even if information decays rapidly and banks learn nothing about borrowers through time these aspects of credit contracting arise in a repeated game context our main results are as follows first despite universal risk neutrality and the absence of learning a durable bank relationship benefits the borrower 2 the intuition is that the long term contracting permitted by a durable relationship enables the bank to efficiently tax and subsidize the borrower through time to reduce the use of costly collateral second the average welfare loss due to moral hazard per period is positive even as the time horizon goes to infinity third the optimal infinite horizon contract has the striking property that following the period

automobile insurance ratemaking in the presence of asymmetrical information automobile insurance is an example of a market where multi period contracts are observed this form of contract can be justified by asymmetrical information between the insurer and the insured insurers use risk classification together with bonus malus systems in this paper we show that the actual methodology for the integration of these two approaches can lead to inconsistencies we develop a statistical model that adequately integrates risk classification and experience rating for this purpose we present poisson and negative binomial models with regression component in order to use all available information in the estimation of accident distribution a bonus malus system which integrates a priori and a posteriori information on an individual basis is proposed and insurance premium tables are derived as a function of time past accidents and the significant variables in the regression statistical results were obtained from a sample of 19 013 drivers

repeated games with long run and short run players this paper studies the set of equilibrium payoffs in repeated games with long and short run players and little discounting because the short run players are unconcerned about the future each equilibrium outcome is constrained to lie on their static reaction best response curves the natural extension of the folk theorem to games of this sort would simply include this constraint in the definitions of the feasible payoffs and minmax values in fact this extension does obtain under the assumption that each player s choice of a mixed strategy for the stage game is publicly observable but in contrast to standard repeated games the set of equilibrium payoffs is different if players can observe only their opponents realized actions

optimal hedge ratios with risk neutral producers and nonlinear borrowing costs a new theory of hedging is derived assuming producers are risk neutral forward pricing is costly and borrowing costs are nonlinear the standard risk minimizing hedge ratio is derived when forward pricing is costless when the assumption of costless hedging is dropped high leveraged firms are shown to hedge more than do low leveraged firms if the value of capital is uncorrelated with output price firms are shown to hedge more as cash price variability increases thus the model can be consistent with what firms actually do

the folk theorem with imperfect public information the authors study repeated games in which players observe a public outcome that imperfectly signals the actions played they provide conditions guaranteeing that any feasible individually rational payoff vector of the stage game can arise as a perfect equilibrium of the repeated game with sufficiently little discounting the central condition requires that there exist action profiles with the property that for any two players no two deviations one by either player give rise to the same probability distribution over public outcomes the results apply to principal agent partnership oligopoly and mechanism design models and to one shot games with transferable utilities copyright 1994 by the econometric society

repeated insurance contracts and learning this article considers a repeated insurance model with incomplete information in which the insurer and the consumer both learn over time about the unknown risk category of the consumer care choices by young consumers affect the informational value of the accident history under an optimal scheme of long term insurance contracts young consumers will always be subsidized by old consumers and consumers who are reassessed as low risk types are always subsidizers i e reverse experience ratings we compare this optimal scheme with the set of contracts that would emerge in a competitive market if only short term contracting were possible these sequentially competitive contracts can lead to over investment in care by both young and old consumers relative to the optimum in contrast to the underinvestment problem associated with moral hazard in insurance

a simple multiperiod minimum risk hedge model a multiperiod hedging model is developed that is simpler than other multiperiod models in the literature the model permits periodic adjustment of the hedge while minimizing the producer s profit variance minimum risk hedge ratios are calculated for steers cows hogs corn and soybeans using the full model with hedge adjustments every two months these ratios are compared to those using the model without periodic hedge adjustments and to a simple single period model the results suggest that simple models may work well for simple hedges while the full model is best for more complex hedging situations such as cross hedges our purpose in this paper is to develop a multiperiod hedging model in which the hedge can be updated each period other multiperiod hedging models e g anderson and danthine karp have substantial data requirements which limit their use as viable hedging tools our aim is to develop a simpler model that will have practical application the model is used to calculate minimum risk hedge ratios for steers cows hogs corn and soybeans and these ratios are compared with hedge ratios based on a multiperiod model in which the hedge cannot be adjusted each period simple minimum risk hedge ratios also are computed for each commodity and compared with the other ratios

expected utility debt equity structure and risk balancing the potential effects of agricultural policy on the financial structure of farms is often not fully considered although it has been recognized that policies that reduce business risk may induce farmers to increase financial risk the effects of income policies on farm leverage have not been investigated this paper explores the relationship between farm policy and debt equity structure for a risk averse expected utility maximizer agricultural economists have demonstrated considerable theoretical interest in the futility of agricultural policy many have suggested that policies increasing farm revenues may well result in higher land prices such that landowners receive a windfall gain but incomes of tenant farmers and new entrants are unchanged gabriel and baker added to this nihilism by suggesting that policies that reduce business risk might induce choices that increase financial risk although this important hypothesis is difficult to test gabriel and baker s empirical results appear to be consistent with their hypothesis this paper suggests an alternative to the gabriel and baker model for analysis of the risk balancing hypothesis that is a structural model of the overall debt equity decision for agricultural proprietors structural variables include not only business risk but also expected return from farm operations expected capital gains from land and interest cost the primary assumptions of the model are that a the proprietor s objective is to maximize the expected utility of the rate of return on equity b the utility function of wealth is negative exponential c a normal distribution exists for the rate of return on assets and d taxes are ignored risk concepts and leverage

a near rational model of the business cycle with wage and price inertia this paper presents a model in which insignificantly suboptimal behavior causes aggregate demand shocks to have significant real effects the individual loss to agents with inertial price wage behavior is second order in terms of the parameter describing the shock while the effect on real economic variables is first order thus significant changes in business activity can be generated by anticipated money supply changes provided that some agents are willing to engage in nonmaximizing behavior which results in small losses

pricing municipal debt pricing municipal debt is a process substantially different from the valuation of corporate liabilities municipalities are not seized upon default therefore they might own additional assets that could he made available to retire debt even when the value of pledged revenues is insufficient to do so however if the value of the municipality s additional assets is only observable privately moral hazard can deter payments from these alterna tive revenue sources a second consequence of lack of seizure is that the municipality survives and might return to the capital markets to raise additional funds in the future this opens an opportunity to induce extraordinary payments from the value of the ad ditional assets through multiperiod pricing controls e g by following defaults with poor pricing for subsequent securities issues

demographic variables in demand analysis in this paper the authors discuss five procedures for incorporating demographic variables into theoretically plausible demand systems translating scaling and the gorman reverse gorman and implicit prais houthakker procedures these five procedures are used to incorporate a single demographic variable the number of children in a household into the generalized ces demand system using household budget data for the united kingdom for the period 1966 1972 excerpt

evidence on the incentive properties of share contracts abstract ever since adam smith share contracts have been condemned for their lack of incentives sharecropping tenants face incentives to undersupply productive inputs since they receive only a fraction of the marginal revenue the empirical literature reports that lands under sharecropping are indeed less productive and employ inputs less intensively than those operated by owners this paper shows that 1 sharecropping and fixed rent tenancy are both associated with low quality lands 2 plots under sharecropping and fixed rent present on average the same unconditional productivity 3 controlling for observed land quality and input use their average productivities are also identical to those of owner operated plots and 4 the input choices satisfy the same profit maximization conditions for all land contracts these results challenge the conventional wisdom connecting sharecropping to incentive distortions they support an alternative view that farmers optimally employ more input resources into

pricing weather derivatives this article presents a general method for pricing weather derivatives specification tests find that a temperature series for fresno ca follows a mean reverting brownian motion process with discrete jumps and autoregressive conditional heteroscedastic errors based on this process we define an equilibrium pricing model for cooling degree day weather options comparing option prices estimated with three methods a traditional burn rate approach a black scholes merton approximation and an equilibrium monte carlo simulation reveals significant differences equilibrium prices are preferred on theoretical grounds so are used to demonstrate the usefulness of weather derivatives as risk management tools for california specialty crop growers

implications of commodity price behavior for marketing strategies prices of agricultural commodities have systematic dynamic components and many agricultural economists have thought that forecasts of this behavior ought to aid marketing decisions thereby raising producers returns but if commodity markets are pricing efficient then noncompetitive profit opportunities should be quickly arbitraged away thus a debate exists about the magnitude of the likely benefits of various marketing strategies herein we address the question what does the literature about commodity price behavior contribute to our understanding of the expected outcomes from alternative marketing strategies our brief answer is as follows spot prices in u s commodity markets typically behave in a way that is consistent with efficient markets systematic behavior persists because of the costs of arbitrage hence price forecasts in the public domain cannot be used to produce returns which are consistently above the competitive norm although low cost strategies to manage price risk exist evaluating the evidence on these topics is not easy however because the price generating processes are complex sometimes prices seem to behave as if a market is inefficient advice based on analyses using short samples should be used with great caution the remainder of the article elaborates

moral hazard insurance claims and repeated insurance contracts the paper develops a simple model of repeated automobile insurance contracts providing a framework for analyzing changes in aggregate insurance data in periods of changes that affect driver incentives experience rating of premiums gives drivers an incentive to exert effort to avoid accidents ex ante moral hazard and an incentive to hide accidents ex post moral hazard the empirical analysis using data from the competitive insurance markets in ontario and alberta over a period of major legislative changes in ontario suggests that much of the recent decline in accidents in ontario was due to an increased incentive to hide accidents jel classification d 12 d82 hasard moral reclamations d assurance et contrats d assurance renouveles le texte developpe un modele simple de contrats d assurance automobile renouveles fournissant un cadre d analyse des donnees d assurance agregees dans des periodes de changement qui affectent les incitations des chauffeurs un regime de primes cotees selon l experience donne aux chauffeurs une incitation a faire des efforts pour eviter les accidents hasard moral ex ante et une incitation a cacher qu il y a eu accident hasard moral ex post l analyse empirique utilisant les donnees recueillies dans les marches d assurance con currentiels de l ontario et de l alberta pour une periode au cours de laquelle il y a eu des changements legislatifs majeurs en ontario suggere qu une bonne partie du declin des accidents enregistre en ontario a ete attribuable a une incitation accrue a cacher les accidents

more reasons why farmers have so little interest in futures markets the use by farmers of futures contracts and other hedging instruments has been observed to be low in many situations and this has sometimes seemed to be considered surprising or even mysterious we propose that it is in fact readily understandable and consistent with rational decision making standard models of the decision about optimal hedging show that it is negatively related to basis risk to quantity risk and to transaction costs farmers who have less uncertainty about prices and those with a diversified portfolio of investments have lower optimal levels of hedging if a farmer has optimistic price expectations relative to the futures market the incentive to hedge can be greatly reduced and finally farmers who have low levels of risk aversion have little to gain from hedging in terms of risk reduction in that the certainty equivalent payoff at their optimal hedge may be little different than the certainty equivalent under zero hedging these reasons are additional to the argument of simmons 2002 who showed that if capital markets are efficient farmers can manage their risk exposure through adjusting their leverage obviating the need for hedging instruments

adverse selection and finite horizon insurance contracts abstract we use a particular contract to analyze three issues regarding adverse selection monopoly and the use of time within a finite horizon the description and existence of an epsilon equilibrium equilibrium the achievement of a nash equilibrium and the optimality of risk revelation among the results obtained we show that at equilibrium low risk individuals buy full insurance most of the time and high risk individuals always buy full insurance we also show that the equilibrium with risk revelation is a nash equilibrium these results are compared with those of the self selection mechanism stiglitz 1977 and of the equilibrium under moral hazard radner 1981

dynamic contracts with moral hazard and adverse selection we study a novel dynamic principal agent setting with moral hazard and adverse selection persistent as well as repeated in the model an agent whose skills are his private information faces a finite sequence of tasks one after the other upon arrival of each task the agent learns its level of difficulty and then chooses whether to accept or refuse each task in turn and how much effort to exert although his decision to accept or refuse a task is publicly known the agent s effort level is his private information we characterize optimal contracts and show that the per period utility of the agent approaches his per period utility when his skills are publicly known as the discount factor and the time horizon increase

the equivalence of lending equilibria and signalling based insurance under asymmetric information i present a model in which a continuum of individuals have stochastic idiosyncratic income shocks complete insurance is physically feasible but unattainable due to an information asymmetry income shocks are observable only by the individuals receiving them any insurance institution must therefore rely on self reporting of income innovations two ways of achieving incentive compatible self reporting are presented the first is a debt market with an explicit lending restriction the second is an insurance contract that linearly filters a signal transmitted by individuals the two are then demonstrated to be identical equilibrium consumption fluctuates in a random walk which is inefficient given the physical potential for complete insurance but is efficient given the information constraints the results are complementary to those of green 1987 but permit more general stochastic processes of income to be analyzed serial correlation of income reduces the efficiency of the insurance

efficiency wages and equilibrium wages i introduction economists have long sought to explain unemployment in ways consistent with individual agents optimizing behavior a recent although controversial model in this vein is the efficiency wage paradigm which focuses on the difficulty of monitoring worker performance when production is organized in teams to discourage nonperformance by employees firms monitor their workers and dismiss those who are caught shirking a firm may further discourage nonfeasance by paying its workers higher wages than they could earn elsewhere then workers caught shirking not only become unemployed but forfeit the rents associated with their jobs 1 in this scenario in order to maintain the incentives not to shirk firms will not cut wages even though equally qualified unemployed workers are willing to work for less the result is disequilibrium in the labor market and possibly involuntary unemployment 2 a series of theoretical studies have demonstrated the conditions under which efficiency wages may occur standard references include eaton and white 1982 1983 shapiro and stiglitz 1984 foster and wan 1984 bowles 1985 and calvo 1985 yellen 1984 reviews the early literature while katz 1986 stiglitz 1987 and carmichael 1990 discuss more recent work but as carmichael emphasizes in his review few papers have actually attempted to test the predictions of the efficiency wage models most of the existing empirical investigations examine the importance of industrial wage differentials krueger and summers 1987 1988 dickens and katz 1987 and murphy and topel 1987a find that there are substantial unexplained industrial wage differentials which bulow and summers 1986 and krueger and summers 1987 1988 attribute to efficiency wages however the magnitude as well as the interpretation of these industrial wage differentials is disputed see carmichael 1990 leonard 1987 and murphy and topel 1987a 1987b for differing views this paper extends the efficiency wage model in a straightforward way to address two questions will the labor market clear if firms can only imperfectly monitor worker effort and do industrial wage differentials provide a test for the importance of efficiency wages we offer two modifications to traditional efficiency wage models first we recognize that there may be an explicit cost to being fired for instance dismissed workers may find it more difficult to find future employment because of poor references from their previous employer they may incur high psychic costs as a result of being fired or they may have to suffer large search costs in locating another job second we let the firm choose the performance standard 3 it seems only natural that a firm wanting more effort from its employees would hold its workers to a more rigorous performance standard just as a firm seeking a higher quality labor force may require more schooling of its applicants while the firm must compensate the worker for the extra effort necessary to meet the higher performance standard payment of efficiency wages could be avoided following the efficiency wage literature we make the strong assumption that all implicit or explicit bonding mechanisms are prohibitively costly to implement our model of the worker s and firm s behavior is specified in section ii the model includes as special cases a market paying equilibrium wages one paying non market clearing efficiency wages and a dual labor market that is a combination of the two we demonstrate that the firm need not pay efficiency wages even in the presence of the agency problem the use of the performance standard gives the firm another instrument other than the wage to control worker effort and welfare there are limits to how high the performance standard will be adjusted however before the firm will offer an efficiency wage we present the details of these arguments in section iii

an explicit solution for dynamic menu costs with zero discounting abstract in a dynamic stochastic environment small menu costs generate considerable inertia this paper uses the average cost criterion to analyse a model with zero discounting and considers the relationship between the discounted and zero discounting models of dynamic menu costs

multivariate forecasting of a commodity portfolio application to cattle feeding margins and risk traditionally economists have utilized univariate approaches to forecast prices even for firms operating in multicommodity environments this research improves the way in which managerial decision making is analysed by developing a model better representing the price risks and opportunities faced by firms that produce using a portfolio of commodities using the situation of cattle feedlot investors and managers as an example this is accomplished by recognizing the multivariate live cattle feeder cattle and corn prices situation that feedlots operate in and employing corresponding multivariate simulation techniques evaluation suggests that properly modelling the cattle feeding margin as a multivariate set of prices significantly improves the accuracy of forecasting future feeding margin values realized in the cash market the model also suggests incorporating both implied and historical time varying volatility information when forecasting margin variability implications for other multicommodity sit

currency and credit are equivalent mechanisms i study a pure exchange economy with many agents whose marginal utility of consumption is stochastically heterogeneous and independent of wealth with realized marginal utility of wealth private information i show that currency and credit are equivalent to a contract that is efficient when the privacy of information is viewed as a constraint and that the cash in advance constraint is an expression of an incentive constraint

collusion enforcement with private information and private monitoring abstract this paper shows that a cartel that observes neither costs prices nor sales may still enforce a collusive agreement by tying each firm s continuation profit to the truncated current profits of the other firms the mechanism applies to both price and quantity competition and the main features are broadly consistent with common cartel practice identified by harrington and skrzypacz 24

moral hazard land fertility and sharecropping in a rural area of the philippines abstract introducing concerns about land fertility for landlords in a principal agent model of sharecropping with moral hazard we show that the optimal contract under limited commitment reflects a trade off between production and land quality maintenance using data from the philippines a model where the leasing out and contract choices are simultaneous is estimated and avoids the selectivity bias of observed contracts landlords prefer to use more incentive contracts for more fertile plots and less incentive ones when crop choices induce land overuse empirical tests reject the model of pure risk sharing in production and show the interest of taking land quality maintenance into account

further toward a theory of agricultural insurance the economic theory of contracts is applied to agricultural insurance to show that given full information pareto optimal insurance contracts are actuarially fair provide full coverage and differ for each individual the information problems of moral hazard and adverse selection prevent pareto optimality from being attained several second best solutions to these problems are applied to agricultural insurance it is shown that information collection and the application of contract design principles are second best solutions which may achieve the benefits of insurance at less cost than the current practice of public subsidies in theory agricultural insurance is an efficient risk sharing mechanism in practice however agricultural insurance has been a costly means of transferring risk from farmers to governments and or other insurers to induce farmers to participate in agricultural insurance governments have borne significant subsidy costs hazell pomareda and valdes p 295 in a recent study ahsan ali and kurian aak concluded that public subsidies are necessary to make agricultural insurance viable they also showed that insurance will increase output relative to a case with no insurance thus insurance is beneficial particularly in less developed countries where increasing food supplies is a policy goal for this reason they concluded that public subsidization of insurance also is desirable their conclusions are derived from a simplified model of production with one output and one input in this article we consider a more general production model with multiple inputs and outputs we show that aak s conclusion about the benefits of insurance may not hold depending on the nature of the inputs and outputs as defined by the production function carl h nelson is an assistant professor of agricultural economics

unmediated communication in repeated games with imperfect monitoring we show that any correlated equilibrium payoff of two player repeated games with imperfect monitoring and without discounting can be reached as the nash equilibrium payoff of the game extended by a universal mechanism of unmediated communication this result holds regardless the particular concept of equlibrium involved upper lower banach or uniform equlibrium the communication mechanism is built up by using commutative one way functions these functions are designed with the help of cryptographic tools

short term contracting and strategic oil reserves the effect of short term contracting on resource extraction is studied in a two country model of international trade in oil countries planners are assumed to be fully rational with perfect information and perfect foresight contracts are assumed perfectly enforceable and complete except that short term contracts do not allow commitments to actions taken beyond the contract period we show that short term contracting limits countries opportunities for intertemporal consumption smoothing reducing their collective tolerance for temporal variation in consumption this tends to make them extract more slowly than in the efficient plan that results from long term contracting contractual relationships often outlive the contracts that govern them it is therefore common for a long term relationship to be governed by a sequence of short term contracts when these contracts allow complete control of the organization of the relationship within each contract period any outcome that can be achieved in a long term contract covering the entire life of the relationship is also feasible with a sequence of short term contracts short term contracting can nevertheless have significant effects on resource allocation because each contract must be voluntarily negotiated in the environment created by its predecessors an allocation that is acceptable to both parties as a long term contract might not be voluntarily negotiable as a sequence of short term contracts because short term contracting is so prevalent it is worth asking what sorts of relationship can be organized efficiently only by long term contract and what kinds of distortion are caused by short term contracting two kinds of answers to these questions have been given in the literature one important line of investigation considers the use of memory in contracts designed to control parties incentives under asymmetric information baron and besanko 1985 rubinstein and yaari 1983 sanchez and zapater 1985 stiglitz and weiss 1983 tirole 1986 and townsend 1982 among others have shown how parties can use

repeated principal agent relationships with lending and borrowing abstract it is shown optimal long term contracts are strictly better than a series of unrelated short term contracts for two reasons long term contracts allow risk to be spread over time and the agent s intertemporal choices provide information about the unobservable random variable

portfolio theory and the demand for futures the case of california cotton this paper examines the simultaneous choice of cropping patterns and futures positions it derives the demand for hedging as a function of the price of a hedge and the crop choice set it estimates these functions for california cotton farmers it finds that both the costs of hedging and the opportunity to diversify risk by growing other crops substantially change the optimal hedge for california cotton farmers

optimism invites deception recent literature has focused on reputation as a mechanism for partially correcting information asymmetries that can exist in markets where sellers produce an output whose quality is not easily observed by buyers prior to sale then sellers reputation based on past observations can be used by consumers to prejudge quality consumers may pay a premium price for such firms for whom a reputation is a valuable asset in choosing quality anew each period the prospect of future profits from this premium price may dissuade the firm from cheating on quality this theory is developed in klein and leffler 1981 shapiro 1982 1983 dybvig and spatt 1983 rogerson 1983 and allen 1984 this literature has presumed that the quality of firms chosen inputs is perfectly correlated with the quality of their outputs there is no noise in the production process indeed adding noise to a reputation model would seem to be a trivial generalization at first blush we would expect the product of a firm that delivered high quality only 90 percent of the time to be worth roughly 90 percent of the value of the product of a firm that had perfect quality control in this paper we investigate the pure strategy equilibria of a rational expectations model that incorporates quality noise we find that the market for high quality may not be sustainable in the presence of such noise ruling out mixed strategies since consumers cannot observe the quality of a firm s inputs assumed fixed and sunk they must infer this quality from observed outputs in equilibrium consumers initial beliefs about the quality of the firm s inputs are determined by what they correctly predict to be the firm s strategy observations of the output lead them to revise these beliefs in accordance with bayes law if consumers are sure that a firm will purchase good inputs then it pays the firm to cheat and purchase bad inputs since

small menu costs and large business cycles a macroeconomic model of monopoly i introduction the conflict between modern neoclassical and traditional keynesian theories of the business cycle centers upon the pricing mechanism in neoclassical models prices are fully flexible they represent the continuous optimization of economic agents and the continuous intersection of supply and demand in keynesian models prices are often assumed to be sticky they do not necessarily equilibrate all markets at all times one of the reasons for the resurgence of the equilibrium approach to macroeconomics has been the absence of a theoretical underpinning for this keynesian price stickiness this note shows that sticky prices can be both privately efficient and socially inefficient the business cycle results from the suboptimal adjustment of prices in response to a demand shock to the extent that policy can stabilize aggregate demand it can mitigate the social loss due to this suboptimal adjustment in some keynesian models prices are simply exogenously fixed 2 in others agents must set their prices in advance of the transaction date the act of altering a posted price is certainly costly these costs include such items as printing new catalogs and informing salesmen of the new price yet these menu costs are small and therefore generally perceived as providing only a weak foundation for these fixed price models however this inference is flawed small menu costs can cause large welfare losses the claim that price adjustment costs are small does not rebut the claim that they are central to understanding economic fluctuations

repeated insurance contracts with differential learning using principal agent and insurance models several authors recently have shown that inefficiencies arising from asymmetric information between economic agents can be eliminated if the relationship between the agents is enduring and the future is not heavily discounted dionne 1983 radner 1985 radner 1986 rubinstein 1979 rubinstein and yaari 1983 in those models the efficient actions of the parties are common knowledge or it is common knowledge that the party with the private information knows the efficient actions the efficient outcomes are implemented by a statistical scheme comparing realized outcomes with what should have arisen if the efficient actions had been taken this paper studies an insurance model in which the full information efficient actions are not known neither the insurer nor the customer knows the customer s risk characteristics however over time the customer learns about his characteristics and may pass this information on to the insurer though the insurer cannot verify the truthfulness of these reports a customer has good days and bad days on good days it is easier for the customer to prevent accidents the customer s type is the probability with which he has a good day efficient risk sharing between such a risk averse customer and a risk neutral insurer would protect the customer against the randomness in his ability and against loss due to an accident however the insurer appears to be disadvantaged since it cannot observe the customer s actions a moral hazard problem and the customer may become better informed about his own type an adverse selection problem one wonders whether the customer might hide behind a cloak of ignorance about this type in order to exploit his informational advantage in fact i show that in the infinitely repeated model the insurer writing a good faith policy for the customer does implement the full information competitive outcome the insurer takes as true the customer s ability reports and updates its beliefs about the agent s type if the customer s record with the insurer is satisfactory then the insurer offers to this customer the best full information zero profit contract for a customer whose type is given by the mean of these updated beliefs otherwise a high premium is charged until a satisfactory record is regained the martingale version of the law of the iterated

pricing weather insurance with a random strike price the ontario ice wine harvest weather insurance within the agricultural sector has been limited by the difficulty in defining the appropriate weather event and in pricing the product we develop a new pricing method for weather insurance under situations where returns depend not only on the occurrence of the weather event but also its timing the method is used to price weather insurance for ice wine because the harvest quantity of grapes for ice wine degrades over time the strike value on the weather event measured as harvestable hours is random we develop a monte carlo method to estimate the premium

repeated insurance contracts and moral hazard abstract an attempt is made to account for the frequently observed phenomenon of insurance companies offering discounts to clients who possess a favorable record of past claims we argue that such discounts provide a mechanism which enables both insurer and insured to counteract the inefficiency which arises from moral hazard

why are prices sticky the dynamics of wholesale gasoline prices the menu cost interpretation of sticky prices implies that the probability of a price change should depend on the past history of prices and fundamentals only through the gap between the current price and the frictionless price we find that this prediction is broadly consistent with the behavior of nine philadelphia gasoline wholesalers nevertheless we reject the menu cost model as a literal description of these firms behavior arguing instead that price stickiness arises from strategic considerations of how customers and competitors will react to price changes

insurability and moral hazard in agricultural insurance markets pareto optimal and constrained pareto optimal all risk insurance contracts are studied conditions required for emergence of competitive insurance markets are isolated and discussed full insurance contracts are shown to be dominated by contracts involving coinsurance and deductibles if insurers are pseudo risk averse the effect of moral hazard on all risk agricultural insurance indemnity schedules is examined results for indemnity schedules under moral hazard and constant absolute risk aversion show that providing farmers with the incentives to take appropriate actions may imply lower deductibles in the presence of moral hazard than in the absence of moral hazard

the importance of financial leverage and risk aversion in risk management strategy selection the problem of choice among risk management strategies is addressed with the stochastic dominance with a risk free asset sdra criteria the sdra criteria consider all possible combinations of the strategies and financial leverage this allows for strategies with less business risk less expected return and greater leverage to dominate strategies with greater business risk and greater expected return results show that the inclusion of the risk free asset significantly improves the discriminatory power of the ordinary stochastic dominance criteria for the case of risk management strategies copyright 2002 oxford university press

on repeated moral hazard with discounting in this paper we analyze optimal contracts in an infinitely repeated agency model in which both the principal and agent discount the future we show that there is a stationary representation of the optimal contract when the agent s conditional discounted expected utility is used as a state variable this representation reduces the multi period problem to a static variational problem which can be analyzed using standard variational techniques this reduction is used to obtain several properties of the contract

the multiperiod principal agent problem in repeated principal agent models long term contracts can improve on short term contracts only if they commit either principal or agent to a payoff in some future circumstance lower than could be obtained from a short term contract negotiated if that circumstance occurs we show that efficient contracting under moral hazard alone does not require long term commitment from the principal provided a short term contract can punish the agent sufficiently in a sense made precise it requires no commitment from the agent either then linking payoffs in one period to outcomes in previous periods does not improve the tradeoff between incentives and risk sharing

aggregate fluctuations interest rates and repeated insurance under private information using a linear quadratic framework i show i the formal equivalence of lending and optimal insurance when information about states is private ii that lending equilibria induce the serial correlation patterns of aggregate and individual stochastic processes of consumption to be identical even if the corresponding income processes differ iii the influence of the interest rate and the underlying serial correlation of the aggregate income process on potential insurance available in lending markets iv the breakdown of individual rationality of the repeated private information contract and corresponding equilibria via defection to autarky as an initial exploration of the force needed by an external mechanism that might prevent this defection i analyze the average gain from defection finding that the average gain from defection increases with the serial correlation of idiosyncratic income associating defection with low interest rates

how restrictive is the prais houthakker model abstract the prais houthakker model has been commonly used in the analysis of the influence of socio demographic variables on household consumption behavior however it has been recently criticized for being too restrictive this paper derives the necessary and sufficient conditions that make the prais houthakker model consistent with consumer theory while some restrictions presented in the literature are sufficient to make the prais houthakker model consistent with consumer theory less restrictive conditions are derived that can validate the prais houthakker model on theoretical grounds