Contracts and Market: Risk Sharing with Hidden Types
AbstractI 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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Bibliographic InfoPaper provided by ULB -- Universite Libre de Bruxelles in its series Working Papers ECARES with number ECARES 2011-005.
Length: 26 p.
Date of creation: Feb 2011
Date of revision:
Publication status: Published by:
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-03-05 (All new papers)
- NEP-BEC-2011-03-05 (Business Economics)
- NEP-CTA-2011-03-05 (Contract Theory & Applications)
- NEP-MIC-2011-03-05 (Microeconomics)
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