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Optimal contracts and competitive markets with costly state verification

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  • Townsend, Robert M.

Abstract

This paper focuses on avoidable moral hazard and offers one explanation for limited insurance markets, for closely held firms, and for seemingly simple as opposed to contingent forms of debt. Agents have random endowments of a consumption good which are such that there are gains to trading contingent claims. But any realization of an endowment is known only by its owner unless a verification cost is borne. Contracts in such a setting are said to be consistent if agents submit to verification and honor claims in accordance with prior agreements. The Pareto optimal consistent contracts which emerge are shown to have familiar characteristics.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Economic Theory.

Volume (Year): 21 (1979)
Issue (Month): 2 (October)
Pages: 265-293

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Handle: RePEc:eee:jetheo:v:21:y:1979:i:2:p:265-293

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Web page: http://www.elsevier.com/locate/inca/622869

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  1. Arrow, Kenneth J, 1974. "Limited Knowledge and Economic Analysis," American Economic Review, American Economic Association, vol. 64(1), pages 1-10, March.
  2. Caspi, Yaffa Machnes, 1978. "A Limit Theorem on the Core of an Economy with Individual Risks," Review of Economic Studies, Wiley Blackwell, vol. 45(2), pages 267-71, June.
  3. Sanford J Grossman & Joseph E Stiglitz, 1997. "On the Impossibility of Informationally Efficient Markets," Levine's Working Paper Archive 1908, David K. Levine.
  4. Shavell, Steven, 1979. "On Moral Hazard and Insurance," The Quarterly Journal of Economics, MIT Press, vol. 93(4), pages 541-62, November.
  5. Spence, Michael & Zeckhauser, Richard, 1971. "Insurance, Information, and Individual Action," American Economic Review, American Economic Association, vol. 61(2), pages 380-87, May.
  6. Hirshleifer, Jack, 1971. "The Private and Social Value of Information and the Reward to Inventive Activity," American Economic Review, American Economic Association, vol. 61(4), pages 561-74, September.
  7. Rothschild, Michael & Stiglitz, Joseph E., 1970. "Increasing risk: I. A definition," Journal of Economic Theory, Elsevier, vol. 2(3), pages 225-243, September.
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