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Optimal contract design via relaxation: application to the problem of brokerage fee for a client with private signal

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  • Guillermo Alonso Alvarez
  • Sergey Nadtochiy

Abstract

In this paper we show how the relaxation techniques can be used to establish the existence of an optimal contract in presence of information asymmetry. The method we illustrate was initially motivated by the problem of designing optimal brokerage fees, but it does apply to other optimal contract problems, in which (i) the agent controls linearly the drift of a diffusion process, (ii) the direct dependence of the principal's and the agent's objectives on the strategy of the agent is of a special form, and (iii) the space of admissible contracts is compact. This method is then applied to establish existence of an optimal brokerage fee in a market model with a private trading signal observed by the broker's client but not by the broker.

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  • Guillermo Alonso Alvarez & Sergey Nadtochiy, 2023. "Optimal contract design via relaxation: application to the problem of brokerage fee for a client with private signal," Papers 2307.07010, arXiv.org.
    • Handle: RePEc:arx:papers:2307.07010
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    References listed on IDEAS

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    1. Yuliy Sannikov, 2008. "A Continuous-Time Version of the Principal-Agent Problem," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 75(3), pages 957-984.
    2. Noah Williams, 2011. "Persistent Private Information," Econometrica, Econometric Society, vol. 79(4), pages 1233-1275, July.
    3. Holmstrom, Bengt & Milgrom, Paul, 1987. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Econometrica, Econometric Society, vol. 55(2), pages 303-328, March.
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    Cited by:

    1. Daniel Krv{s}ek & Dylan Possamai, 2023. "Randomisation with moral hazard: a path to existence of optimal contracts," Papers 2311.13278, arXiv.org.

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