Risk Sharing in an Adverse Selection Model
Résumé
We introduce risk aversion in a mixed moral hazard/adverse selection model. Under plausible
assumptions, the effort level of the firm is distorted downward from the first best level of effort
for both agent types. Thus, the traditional result of no distortion on the top does not hold with
risk aversion. We also show that the effort level of the low-cost type may be distorted more
than that of the high cost type. With an observable cost shock, an increase in exogenous risk
may increase the effort level of the efficient firm and lower the expected cost of the project.
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