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Computation of Moral-Hazard Problems


  • Kenneth L. Judd
  • Che-Lin Su

    () (Hoover Institute Hoover Institution)


We study computational aspects of moral-hazard problems. We consider deterministic contracts as well as contracts with action and/or compensation lotteries, and formulate each case as a mathematical program with equilibrium constraints (MPEC). We investigate and compare solution properties of the MPEC approach with the linear programming (LP) approach with lotteries. We propose a hybrid procedure that combines the best features of the both. The hybrid procedure obtains a solution that is, if not globally optimal, at least as good as an LP solution. It also preserves the fast local convergence property by applying the SQP algorithm to MPECs. Numerical examples show that the hybrid procedure outperforms the LP approach in both computational time and solution quality in term of the optimal objective value

Suggested Citation

  • Kenneth L. Judd & Che-Lin Su, 2005. "Computation of Moral-Hazard Problems," Computing in Economics and Finance 2005 411, Society for Computational Economics.
  • Handle: RePEc:sce:scecf5:411

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    References listed on IDEAS

    1. Robert Engle, 2002. "New frontiers for arch models," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 17(5), pages 425-446.
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    6. Torben G. Andersen & Tim Bollerslev, 1996. "DM-Dollar Volatility: Intraday Activity Patterns, Macroeconomic Announcements, and Longer Run Dependencies," NBER Working Papers 5783, National Bureau of Economic Research, Inc.
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    More about this item


    MPEC problems; moral hazard; lottery problems;

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques


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