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Robust Moral Hazard with Distributional Ambiguity

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  • Li, Zhaolin

Abstract

We present a moral hazard model in which both the entrepreneur and investor face limited liability and employ a robust decision rule that maximizes their worst-case expected profit when distributional ambiguity exists. Applying strong duality, we reformulate the robust moral hazard model by introducing a new set of incentive compatibility constraints associated with choosing the most unfavourable distribution. We develop a one-step-ahead method using shadow prices for such probabilistic resources as mean and variance to characterize the robustly optimal contract and to improve the commonly used debt contract.

Suggested Citation

  • Li, Zhaolin, 2020. "Robust Moral Hazard with Distributional Ambiguity," Working Papers BAWP-2020-03, University of Sydney Business School, Discipline of Business Analytics.
    • Handle: RePEc:syb:wpbsba:2123/23549
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    1. Ramsebner, J. & Haas, R. & Auer, H. & Ajanovic, A. & Gawlik, W. & Maier, C. & Nemec-Begluk, S. & Nacht, T. & Puchegger, M., 2021. "From single to multi-energy and hybrid grids: Historic growth and future vision," Renewable and Sustainable Energy Reviews, Elsevier, vol. 151(C).

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    Keywords

    Debt contract; Moral hazard; Robust optimization;
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