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A Matter of Interpretation: Bargaining over Ambiguous Contracts

  • Simon Grant


    (Department of Economics, Rice University)

  • Jeff Kline


    (Department of Economics, University of Queensland)

  • John Quiggin


    (Department of Economics, University of Queensland)

We present a formal treatment of contracting in the face of ambiguity. The central idea is that boundedly rational individuals will not always interpret the same situation in the same way. More specifically, even with well defined contracts, the precise actions to be taken by each party to the contract might be disputable. Taking this potential for dispute into account, we analyze the effects of ambiguity on contracting. We find that risk averse agents will engage in ambiguous contracts for risk sharing reasons. We provide an application where ambiguity motivates the use of a liquidated damages contract.

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Paper provided by Risk and Sustainable Management Group, University of Queensland in its series Risk & Uncertainty Working Papers with number WPR09_3.

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Date of creation: Nov 2009
Date of revision:
Handle: RePEc:rsm:riskun:r09_3
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  1. Sujoy Mukerji & Jean-Marc Tallon, 2000. "Ambiguity Aversion and Incompleteness of Financial Markets," Economics Series Working Papers 46, University of Oxford, Department of Economics.
  2. Ilya Segal, 1999. "Complexity and Renegotiation: A Foundation for Incomplete Contracts," Review of Economic Studies, Oxford University Press, vol. 66(1), pages 57-82.
  3. Eric Maskin & Jean Tirole, 1999. "Unforeseen Contingencies and Incomplete Contracts," Review of Economic Studies, Oxford University Press, vol. 66(1), pages 83-114.
  4. Itzhak Gilboa & David Schmeidler, 1989. "Maxmin Expected Utility with Non-Unique Prior," Post-Print hal-00753237, HAL.
  5. Heifetz, Aviad & Meier, Martin & Schipper, Burkhard C., 2006. "Interactive unawareness," Journal of Economic Theory, Elsevier, vol. 130(1), pages 78-94, September.
  6. Kim-Sau Chung & Oliver Board, 2007. "Object-Based Unawareness," Working Papers 2007-2, University of Minnesota, Department of Economics, revised 24 Aug 2007.
  7. B. Douglas Bernheim & Michael D. Whinston, 1997. "Incomplete Contracts and Strategic Ambiguity," Harvard Institute of Economic Research Working Papers 1787, Harvard - Institute of Economic Research.
  8. Oliver Hart & John Moore, 1998. "Foundations of Incomplete Contracts," NBER Working Papers 6726, National Bureau of Economic Research, Inc.
  9. Grant, Simon & Kajii, Atsushi, 1995. "A Cardinal Characterization of the Rubinstein-Safra-Thomson Axiomatic Bargaining Theory," Econometrica, Econometric Society, vol. 63(5), pages 1241-49, September.
  10. Mukerji, Sujoy, 1998. "Ambiguity Aversion and Incompleteness of Contractual Form," American Economic Review, American Economic Association, vol. 88(5), pages 1207-31, December.
  11. Chew Soo Hong & Jacob S. Sagi, 2006. "Event Exchangeability: Probabilistic Sophistication Without Continuity or Monotonicity," Econometrica, Econometric Society, vol. 74(3), pages 771-786, 05.
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