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The trade-off between incentives and endogenous risk

Aloisio Araujo and Humberto Moreira ()

No 152, Econometric Society 2004 Latin American Meetings from Econometric Society

Abstract: Standard models of moral hazard predict a negative relationship between risk and incentives, but the empirical work has not confirmed this prediction. In this paper, we propose a model with adverse selection followed by moral hazard, where effort and the degree of risk aversion are private information of an agent who can control the mean and the variance of profits. For a given contract, more risk-averse agents supply more effort in risk reduction. If the marginal utility of incentives decreases with risk aversion, more risk-averse agents prefer lower-incentive contracts; thus, in the optimal contract, incentives are positively correlated with endogenous risk. In contrast, if risk aversion is high enough, the possibility of reduction in risk makes the marginal utility of incentives increasing in risk aversion and, in this case, risk and incentives are negatively related

Keywords: Incentives; non-monotone contracts; single-crossing property. (search for similar items in EconPapers)
JEL-codes: D82 M52 (search for similar items in EconPapers)
Date: 2004-08-11
References: Add references at CitEc
Citations: View citations in EconPapers (2)

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http://repec.org/esLATM04/up.578.1081959082.pdf (application/pdf)

Related works:
Journal Article: The Trade-Off Between Incentives and Endogenous Risk (2007) Downloads
Working Paper: The trade-off between incentives and endogenous risk (2004) Downloads
Working Paper: The trade-off between incentives and endogenous risk (2004) Downloads
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