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On the first-order approach in principal-agent models with hidden borrowing and lending

  • Ábrahám, Árpád
  • Koehne, Sebastian
  • Pavoni, Nicola

We provide sufficient conditions for the validity of the first-order approach for two-period dynamic moral hazard problems where the agent can save and borrow secretly. The first-order approach is valid if the following conditions hold: (i) the agent has non-increasing absolute risk aversion utility (NIARA), (ii) the output technology has monotone likelihood ratios (MLR), and (iii) the distribution function of output is log-convex in effort (LCDF). Moreover, under these three conditions, the optimal contract is monotone in output. We also investigate a few possibilities of relaxing these requirements.

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Article provided by Elsevier in its journal Journal of Economic Theory.

Volume (Year): 146 (2011)
Issue (Month): 4 (July)
Pages: 1331-1361

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Handle: RePEc:eee:jetheo:v:146:y:2011:i:4:p:1331-1361
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  1. Chiappori, P.A. & Macho, I. & Rey, P. & Salanié, B., 1989. "Repeated Moral Hazard: The Role of Memory, Commitment, and the Access to Credit Markets," DELTA Working Papers 89-18, DELTA (Ecole normale supérieure).
  2. John R. Conlon, 2009. "Two New Conditions Supporting the First-Order Approach to Multisignal Principal-Agent Problems," Econometrica, Econometric Society, vol. 77(1), pages 249-278, 01.
  3. Arpad Abraham & Nicola Pavoni, 2008. "Code for "Efficient Allocations with Moral Hazard and Hidden Borrowing and Lending: A Recursive Formulation"," Computer Codes 06-26, Review of Economic Dynamics.
  4. Mitchell, Matthew & Zhang, Yuzhe, 2010. "Unemployment Insurance with Hidden Savings," MPRA Paper 23214, University Library of Munich, Germany.
  5. In-Uck Park, 2004. "Moral Hazard Contracting and Private Credit Markets," Econometrica, Econometric Society, vol. 72(3), pages 701-746, 05.
  6. Abraham Arpad & Nicola Pavoni, 2004. "Efficient Allocations, with Moral Hazard and Hidden Borrowing and Lending," Levine's Bibliography 122247000000000138, UCLA Department of Economics.
  7. University of Venice & Nicola Pavoni & Piero Gottardi, 2008. "Ramsey Asset Taxation under Asymmetric Information," 2008 Meeting Papers 309, Society for Economic Dynamics.
  8. Domeij, David & Floden, Martin, 2001. "The labor-supply elasticity and borrowing constraints: Why estimates are biased," SSE/EFI Working Paper Series in Economics and Finance 480, Stockholm School of Economics.
  9. Andrew Atkeson, 2010. "International lending with moral hazard and risk of repudiation," Levine's Working Paper Archive 200, David K. Levine.
  10. Allen, Franklin, 1985. "Repeated principal-agent relationships with lending and borrowing," Economics Letters, Elsevier, vol. 17(1-2), pages 27-31.
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