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Regulatory Policy Design in an Uncertain World


The paper examines principal-agent relationships in uncertain environments where beliefs of the contracting parties (the regulator and the firm) are represented by sets of probabilities. In addition to fully characterizing the first-best and the second-best solutions, we examine optimality of zero-risk, fixed-payment schemes and the relationship between the first-best and the second-best solutions. In the second-best world, where the regulator can only contract on the quality of the good, a zero-risk standard is optimal when the firm has beliefs that are so ambiguous that the firm's marginal rate of transformation belongs to the set of the firm's relative probabilities. Copyright � 2010 Wiley Periodicals, Inc..

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Article provided by Association for Public Economic Theory in its journal Journal of Public Economic Theory.

Volume (Year): 12 (2010)
Issue (Month): 6 (December)
Pages: 1081-1107

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Handle: RePEc:bla:jpbect:v:12:y:2010:i:6:p:1081-1107
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