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Risk Contracts with Private Information and One-Sided Commitment

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  • Eduardo Zilberman

    (Department of Economics PUC-Rio)

  • Pedro Hemsley

    (Department of Economics UERJ)

Abstract

In an endowment economy in which agents negotiate long-term contracts with a financial intermediary, we study the implication of the interaction between incentive compatibility and participation constraints for risk sharing. In particular, we assume that after a default episode, agents consume their endowment and remain in autarky forever. Theoretically, we show that in autarky, the principal cannot spread continuation values to provide incentives except for the agent that draws the highest realization of the endowment. If the probability of such event is small enough then autarky is a persistent state. Numerically, we explore this implication to argue that the optimal contract prevents agents from reaching autarky when the probability of drawing the highest realization of the endowment is small enough.

Suggested Citation

  • Eduardo Zilberman & Pedro Hemsley, 2015. "Risk Contracts with Private Information and One-Sided Commitment," Textos para discussão 635, Department of Economics PUC-Rio (Brazil).
    • Handle: RePEc:rio:texdis:635
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    References listed on IDEAS

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