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Optimal contracts and competitive markets with costly state verification

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  • Robert Townsend

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.

(This abstract was borrowed from another version of this item.)

(This abstract was borrowed from another version of this item.)

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Bibliographic Info

Paper provided by Federal Reserve Bank of Minneapolis in its series Staff Report with number 45.

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Date of creation: 1979
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Handle: RePEc:fip:fedmsr:45

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References

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  1. Sanford J Grossman & Joseph E Stiglitz, 1997. "On the Impossibility of Informationally Efficient Markets," Levine's Working Paper Archive 1908, David K. Levine.
  2. Spence, Michael & Zeckhauser, Richard, 1971. "Insurance, Information, and Individual Action," American Economic Review, American Economic Association, vol. 61(2), pages 380-87, May.
  3. Rothschild, Michael & Stiglitz, Joseph E., 1970. "Increasing risk: I. A definition," Journal of Economic Theory, Elsevier, vol. 2(3), pages 225-243, September.
  4. Stephen A. Ross, 1977. "The Determination of Financial Structure: The Incentive-Signalling Approach," Bell Journal of Economics, The RAND Corporation, vol. 8(1), pages 23-40, Spring.
  5. Robert Wilson, 1975. "Informational Economies of Scale," Bell Journal of Economics, The RAND Corporation, vol. 6(1), pages 184-195, Spring.
  6. 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.
  7. 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.
  8. Shavell, Steven, 1979. "On Moral Hazard and Insurance," The Quarterly Journal of Economics, MIT Press, vol. 93(4), pages 541-62, November.
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