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Moral Hazard and Entrepreneurial Failure in a Two-sector Model of Productive Matching - with an Application to the Natural Resource Curse

  • Perroni, Carlo

    (University of Warwick)

  • Proto, Eugenio

    (University of Warwick)

We analyze a two-sector, general-equilibrium model of productive matching and sorting, where risky production is carried out by pairs of individuals both exerting effort. Risk-neutral (entrepreneurial) individuals can match either with other risk-neutral individuals, or – acting as employers/ insurers – with risk-averse (nonentrepreneurial) individuals. Although the latter option has the potential to generate more surplus, when effort is unobservable and risk is high, the moral hazard problem in mixed matches may be too severe for mixing to be attractive to both risk aversion types, leading to a segregated equilibrium in which risk-averse individuals select low-risk, low-yielding activities. An increase in the return associated with the riskier sector can then trigger a switch from a mixed to a segregated equilibrium, causing aggregate output to fall.

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File URL: http://www2.warwick.ac.uk/fac/soc/economics/research/workingpapers/2008/twerp_796.pdf
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Paper provided by University of Warwick, Department of Economics in its series The Warwick Economics Research Paper Series (TWERPS) with number 796.

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Length: 25 pages
Date of creation: 2007
Date of revision:
Handle: RePEc:wrk:warwec:796
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