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Framing contingencies in contracts


  • Zhao, Xiaojian


This paper develops a contracting model in which the principal frames the contract when the agent is unaware of some contingencies, yet is aware that she may be unaware. We call the contract vague if the agent is still unaware of some contingencies after understanding the contract. We show that the optimal contract is vague if and only if the principal exploits the agent. Applying the model to an insurance problem, we show the insuree is free from exploitation if she slightly underestimates the unforeseen calamities. In a contracting problem, whenever the contractor is unaware of the force majeure event, she is exploited by the employer.

Suggested Citation

  • Zhao, Xiaojian, 2011. "Framing contingencies in contracts," Mathematical Social Sciences, Elsevier, vol. 61(1), pages 31-40, January.
  • Handle: RePEc:eee:matsoc:v:61:y:2011:i:1:p:31-40

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    References listed on IDEAS

    1. Jean Tirole, 2009. "Cognition and Incomplete Contracts," American Economic Review, American Economic Association, vol. 99(1), pages 265-294, March.
    2. Kim-Sau Chung & Oliver Board, 2007. "Object-Based Unawareness," Working Papers 2007-2, University of Minnesota, Department of Economics, revised 24 Aug 2007.
    3. Li, Jing, 2009. "Information structures with unawareness," Journal of Economic Theory, Elsevier, vol. 144(3), pages 977-993, May.
    4. Sendhil Mullainathan & Joshua Schwartzstein & Andrei Shleifer, 2008. "Coarse Thinking and Persuasion," The Quarterly Journal of Economics, Oxford University Press, vol. 123(2), pages 577-619.
    5. Eric Maskin & Jean Tirole, 1999. "Unforeseen Contingencies and Incomplete Contracts," Review of Economic Studies, Oxford University Press, vol. 66(1), pages 83-114.
    6. Xavier Gabaix & David Laibson, 2006. "Shrouded Attributes, Consumer Myopia, and Information Suppression in Competitive Markets," The Quarterly Journal of Economics, Oxford University Press, vol. 121(2), pages 505-540.
    7. Quiggin, John, 1982. "A theory of anticipated utility," Journal of Economic Behavior & Organization, Elsevier, vol. 3(4), pages 323-343, December.
    8. Ernst-Ludwig Von Thadden & Xiaojian Zhao, 2012. "Incentives for Unaware Agents," Review of Economic Studies, Oxford University Press, vol. 79(3), pages 1151-1174.
    9. Heifetz, Aviad & Meier, Martin & Schipper, Burkhard C., 2006. "Interactive unawareness," Journal of Economic Theory, Elsevier, vol. 130(1), pages 78-94, September.
    10. Modica, Salvatore & Rustichini, Aldo, 1999. "Unawareness and Partitional Information Structures," Games and Economic Behavior, Elsevier, vol. 27(2), pages 265-298, May.
    11. Jean Tirole, 1999. "Incomplete Contracts: Where Do We Stand?," Econometrica, Econometric Society, vol. 67(4), pages 741-782, July.
    12. Johnson, Eric J & Hershey, John & Meszaros, Jacqueline & Kunreuther, Howard, 1993. "Framing, Probability Distortions, and Insurance Decisions," Journal of Risk and Uncertainty, Springer, vol. 7(1), pages 35-51, August.
    13. Eddie Dekel & Barton L. Lipman & Aldo Rustichini, 1998. "Standard State-Space Models Preclude Unawareness," Econometrica, Econometric Society, vol. 66(1), pages 159-174, January.
    14. Xiaojian Zhao, 2008. "Moral Hazard With Unawareness," Rationality and Society, , vol. 20(4), pages 471-496, November.
    15. David S. Ahn & Haluk Ergin, 2010. "Framing Contingencies," Econometrica, Econometric Society, vol. 78(2), pages 655-695, March.
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    Cited by:

    1. Feinberg, Yossi, 2012. "Games with Unawareness," Research Papers 2122, Stanford University, Graduate School of Business.
    2. Nicola Pavoni & Sarah Auster, 2016. "Optimal Delegation, Unawareness, and Financial Intermediation," 2016 Meeting Papers 1106, Society for Economic Dynamics.


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