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Aggregate and Idiosyncratic Risk and the Behavior of Individual Preferences under Moral Hazard

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  • Marcelo Bianconi

Abstract

We consider the effect of alternative individual preference towards effort conditional on aggregate risk in a principal-agent relationship under moral hazard. We find that agents can explore a negative correlation between individual preference towards effort and aggregate risk to further diversify idiosyncratic risk and increase expected utility under moral hazard. The variation of individual preference towards effort may mitigate the impact of moral hazard on the risk premium, but we find this to be quantitatively small.

Suggested Citation

  • Marcelo Bianconi, 2004. "Aggregate and Idiosyncratic Risk and the Behavior of Individual Preferences under Moral Hazard," Discussion Papers Series, Department of Economics, Tufts University 0410, Department of Economics, Tufts University.
  • Handle: RePEc:tuf:tuftec:0410
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    File URL: http://ase.tufts.edu/econ/papers/200410.pdf
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    References listed on IDEAS

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    1. Rogerson, William P, 1985. "The First-Order Approach to Principal-Agent Problems," Econometrica, Econometric Society, vol. 53(6), pages 1357-1367, November.
    2. Deaton, Angus, 1991. "Saving and Liquidity Constraints," Econometrica, Econometric Society, vol. 59(5), pages 1221-1248, September.
    3. Pischke, Jorn-Steffen, 1995. "Individual Income, Incomplete Information, and Aggregate Consumption," Econometrica, Econometric Society, vol. 63(4), pages 805-840, July.
    4. Jewitt, Ian, 1988. "Justifying the First-Order Approach to Principal-Agent Problems," Econometrica, Econometric Society, vol. 56(5), pages 1177-1190, September.
    5. Oliver Hart & John Moore, 1999. "Foundations of Incomplete Contracts," Review of Economic Studies, Oxford University Press, vol. 66(1), pages 115-138.
    6. Pierpaolo Battigalli & Giovanni Maggi, 2002. "Rigidity, Discretion, and the Costs of Writing Contracts," American Economic Review, American Economic Association, vol. 92(4), pages 798-817, September.
    7. Bianconi, Marcelo, 2001. "Heterogeneity, Efficiency and Asset Allocation with Endogenous Labor Supply: The Static Case," Manchester School, University of Manchester, vol. 69(3), pages 253-268, June.
    8. Bianconi, Marcelo, 2003. "Private information, growth, and asset prices with stochastic disturbances," International Review of Economics & Finance, Elsevier, vol. 12(1), pages 1-24.
    9. Maskin, Eric & Tirole, Jean, 1992. "The Principal-Agent Relationship with an Informed Principal, II: Common Values," Econometrica, Econometric Society, vol. 60(1), pages 1-42, January.
    10. Christopher Phelan, 1994. "Incentives and Aggregate Shocks," Review of Economic Studies, Oxford University Press, vol. 61(4), pages 681-700.
    11. Oliver Hart & Bengt Holmstrom, 1986. "The Theory of Contracts," Working papers 418, Massachusetts Institute of Technology (MIT), Department of Economics.
    12. Bengt Holmstrom, 1979. "Moral Hazard and Observability," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 74-91, Spring.
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    More about this item

    Keywords

    moral hazard; disutility of effort; incomplete contract; meanvariance tradeoff;

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E0 - Macroeconomics and Monetary Economics - - General
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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