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Why Does It Matter That Beliefs And Valuations Be Correctly Represented?

  • Simon Grant
  • Edi Karni

This article contains an analysis of a simple principal-agent problem illustrating possible problems that may arise when the prinicpal ascribes to the agent subjective probabilities and utilities that are implied by the subjective expected utility model but do not represent the agent's beliefs and valuations. In particular, it is possible that an incentive contract designed by the principal induces the agent to choose an action that is not in the principal's best interest. Copyright 2005 by the Economics Department Of The University Of Pennsylvania And Osaka University Institute Of Social And Economic Research Association.

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Article provided by Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association in its journal International Economic Review.

Volume (Year): 46 (2005)
Issue (Month): 3 (08)
Pages: 917-934

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Handle: RePEc:ier:iecrev:v:46:y:2005:i:3:p:917-934
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  1. Karni, Edi, 1996. "Probabilities and Beliefs," Journal of Risk and Uncertainty, Springer, vol. 13(3), pages 249-62, November.
  2. Edi Karni & Philippe Mongin, 2000. "On the Determination of Subjective Probability by Choices," Management Science, INFORMS, vol. 46(2), pages 233-248, February.
  3. Karni, Edi, 2003. " On the Representation of Beliefs by Probabilities," Journal of Risk and Uncertainty, Springer, vol. 26(1), pages 17-38, January.
  4. HOLMSTROM, Bengt, . "Moral hazard and observability," CORE Discussion Papers RP -379, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  5. Steven Shavell, 1979. "Risk Sharing and Incentives in the Principal and Agent Relationship," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 55-73, Spring.
  6. Colin F. Camerer, 1997. "Progress in Behavioral Game Theory," Journal of Economic Perspectives, American Economic Association, vol. 11(4), pages 167-188, Fall.
  7. Jon Elster, 1998. "Emotions and Economic Theory," Journal of Economic Literature, American Economic Association, vol. 36(1), pages 47-74, March.
  8. Paolo Ghirardato, 2002. "Revisiting Savage in a conditional world," Economic Theory, Springer, vol. 20(1), pages 83-92.
  9. Karni, Edi & Postlewaite, Andrew, 2005. "David Schmeidler," Games and Economic Behavior, Elsevier, vol. 50(1), pages 1-2, January.
  10. Grant, Simon & Karni, Edi, 2004. "A theory of quantifiable beliefs," Journal of Mathematical Economics, Elsevier, vol. 40(5), pages 515-546, August.
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