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Limited Liability, Moral Hazard and Risk Taking - A Safety Net Game Experiment

  • Tibor Neugebauer

    ()

    (Luxembourg School of Finance, University of Luxembourg)

  • Sascha Füllbrunn

    ()

    (Luxembourg School of Finance, University of Luxembourg)

Safety nets may reduce incentives to mitigate risks, and adversely affect people’s behavior. We model the safety net problem as a social dilemma game involving moral hazard, risk taking and limited liability. Individuals take costly measures to avoid a likely loss which, if incurred, is collectively indemnified. The situation is compared to a situation with full liability and the deterministic benchmark, i.e. the public goods game. We report experimental results. The data show that limited " liability leads to higher risk taking in comparison to full liability; however, the" difference is much smaller than predicted by theory. In comparison to the deterministic benchmark, individuals take higher loss avoidance levels. We attribute this effect to social responsibility since subjects behave as if they were liable for the losses they impose on the group. With repetition, the experimental data indicate a gradual emergence of the moral hazard problem in safety nets.

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Paper provided by Luxembourg School of Finance, University of Luxembourg in its series LSF Research Working Paper Series with number 10-04.

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Date of creation: 2010
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Handle: RePEc:crf:wpaper:10-04
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  1. Di Mauro, Carmela, 2002. "Ex ante and ex post moral hazard in compensation for income losses: results from an experiment," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, vol. 31(3), pages 253-271.
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