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Contracts and Market: Risk Sharing with Hidden Types

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  • Guido Maretto
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    Abstract

    I study two way effects between financial markets and other contractual agreements, such as compensation packages within a firm, or mortgages and loans. I construct a model with many Units, in which one of the contracting individuals, the Agent, has private information, while the uninformed individual, the Principal, has the opportunity to trade with those in the other Units. I give general conditions under which financial markets induce a transfer of risk from Agents to Principals. These conditions boil down to a limited amount of correlation among Units' returns. Under the same conditions, I show that markets induce a transfer of welfare from the best Agents to Principals. Conversely, the information problem within firms leads to excessive aggregate risk. However, this problem vanishes in a large economy.

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    File URL: https://dipot.ulb.ac.be/dspace/bitstream/2013/76053/4/2011-005-MARETTO-contracts.pdf
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    Bibliographic Info

    Paper provided by ULB -- Universite Libre de Bruxelles in its series Working Papers ECARES with number ECARES 2011-005.

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    Length: 26 p.
    Date of creation: Feb 2011
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    Publication status: Published by:
    Handle: RePEc:eca:wpaper:2013/76053

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    1. Nielsen, Lars Tyge, 1990. "Existence of equilibrium in CAPM," Journal of Economic Theory, Elsevier, vol. 52(1), pages 223-231, October.
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    8. Legros, Patrick & Newman, Andrew F., 1996. "Wealth Effects, Distribution, and the Theory of Organization," Journal of Economic Theory, Elsevier, vol. 70(2), pages 312-341, August.
    9. William R. Zame, 2005. "Incentives, Contracts And Markets: A General Equilibrium Theory Of Firms," UCLA Economics Working Papers 843, UCLA Department of Economics.
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