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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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File URL: http://www.sciencedirect.com/science/article/pii/S0022053111000214
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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
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622869

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