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Efficient Allocations with Moral Hazard and Hidden Borrowing and Lending

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  • Abraham, Arpad
  • Pavoni, Nicola

Abstract

We analyze a dynamic moral hazard setting, in which agents can borrow and lend and their decisions about effort, consumption and savings are private information. In contrast with previous findings, we show that as long as agents do not have perfect control over publicly observable outcomes, the efficient allocation is welfare improving with respect to the case where the agents can self insure only through borrowing and lending. We identify the main sources of welfare improvement, and we compute substantial efficiency gains. We provide a tractable recursive framework to study the optimal allocation in this setting. The dynamic programming formulation is based on a generalized first order approach, whose validity is verified ex post, using a parsimonious numerical procedure based on the recursive formulation itself.

Suggested Citation

  • Abraham, Arpad & Pavoni, Nicola, 2004. "Efficient Allocations with Moral Hazard and Hidden Borrowing and Lending," Working Papers 04-05, Duke University, Department of Economics.
    • Handle: RePEc:duk:dukeec:04-05
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    Cited by:

    1. Noah Williams, 2004. "On Dynamic Principal-Agent Problems in Continuous Time," Levine's Bibliography 122247000000000426, UCLA Department of Economics.
    2. Yuzhe Zhang & Matthew Mitchell, 2007. "Optimal Unemployment Insurance with Hidden Trade," 2007 Meeting Papers 1023, Society for Economic Dynamics.
    3. Nicola Pavoni & G. L. Violante, 2007. "Optimal Welfare-to-Work Programs," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 74(1), pages 283-318.
    4. Setty, Ofer, 2011. "Unemployment Accounts," Foerder Institute for Economic Research Working Papers 275748, Tel-Aviv University > Foerder Institute for Economic Research.
    5. Mikhail Golosov & Aleh Tsyvinski, 2007. "Optimal Taxation with Endogenous Insurance Markets," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 122(2), pages 487-534.
    6. Jarque, Arantxa, 2010. "Repeated moral hazard with effort persistence," Journal of Economic Theory, Elsevier, vol. 145(6), pages 2412-2423, November.
    7. Costa, Carlos Eugênio da & Maestri, Lucas Jóver, 2005. "The interaction between unemployment insurance and human capital policies," FGV EPGE Economics Working Papers (Ensaios Economicos da EPGE) 595, EPGE Brazilian School of Economics and Finance - FGV EPGE (Brazil).
    8. Matthias Messner & Nicola Pavoni, 2004. "On the Recursive Saddle Point Method," Levine's Bibliography 122247000000000050, UCLA Department of Economics.
    9. Karaivanov, Alexander K. & Martin, Fernando M., 2018. "Markov-perfect risk sharing, moral hazard and limited commitment," Journal of Economic Dynamics and Control, Elsevier, vol. 94(C), pages 1-23.
    10. Emilio Espino & Julian Kozlowski & Juan M. Sanchez, 2013. "Too big to cheat: Efficiency and Investment in Partnerships," Working Papers 2013-001, Federal Reserve Bank of St. Louis.
    11. Josepa Miquel-Florensa, 2013. "Dynamic contractual incentives in the face of a Samaritans’s dilemma," Theory and Decision, Springer, vol. 74(1), pages 151-166, January.
    12. Orazio P. Attanasio & Guglielmo Weber, 2010. "Consumption and Saving: Models of Intertemporal Allocation and Their Implications for Public Policy," Journal of Economic Literature, American Economic Association, vol. 48(3), pages 693-751, September.
    13. Marek Kapicka, 2006. "Optimal Income Taxation with Human Capital Accumulation and Limited Record Keeping," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(4), pages 612-639, October.
    14. Noah Williams, 2011. "Persistent Private Information," Econometrica, Econometric Society, vol. 79(4), pages 1233-1275, July.
    15. Alexander Karaivanov & Fernando Martin, 2015. "Dynamic Optimal Insurance and Lack of Commitment," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 18(2), pages 287-305, April.
    16. Mitchell, Matthew & Zhang, Yuzhe, 2010. "Unemployment insurance with hidden savings," Journal of Economic Theory, Elsevier, vol. 145(6), pages 2078-2107, November.
    17. Hassler, John & Rodriguez Mora, José V., 2002. "Should UI Benefits Really Fall Over Time?," IZA Discussion Papers 622, Institute of Labor Economics (IZA).
    18. Álvarez-Parra, Fernando & Sánchez, Juan M., 2009. "Unemployment insurance with a hidden labor market," Journal of Monetary Economics, Elsevier, vol. 56(7), pages 954-967, October.
    19. Narayana Kocherlakota, 2004. "Figuring out the Impact of Hidden Savings on Optimal Unemployment Insurance," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(3), pages 541-554, July.
    20. Orazio P. Attanasio & Nicola Pavoni, 2011. "Risk Sharing in Private Information Models With Asset Accumulation: Explaining the Excess Smoothness of Consumption," Econometrica, Econometric Society, vol. 79(4), pages 1027-1068, July.
    21. Mikhail Golosov & Aleh Tsyvinski, 2003. "Designing optimal disability insurance," Working Papers 628, Federal Reserve Bank of Minneapolis.
    22. Mele, Antonio, 2014. "Repeated moral hazard and recursive Lagrangeans," Journal of Economic Dynamics and Control, Elsevier, vol. 42(C), pages 69-85.
    23. Mikhail Golosov & Aleh Tsyvinski, 2006. "Designing Optimal Disability Insurance: A Case for Asset Testing," Journal of Political Economy, University of Chicago Press, vol. 114(2), pages 257-279, April.
    24. Arpad Abraham & Nicola Pavoni, 2008. "Efficient Allocations with Moral Hazard and Hidden Borrowing and Lending: A Recursive Formulation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(4), pages 781-803, October.

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    Keywords

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    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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