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Efficient Allocations with Moral Hazard and Hidden Borrowing and Lending

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Author Info
Abraham, Arpad
Pavoni, Nicola

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Abstract

We analyze a dynamic moral hazard setting, in which agents can borrow and lend and their decisions about effort, consumption and savings are private information. In contrast with previous findings, we show that as long as agents do not have perfect control over publicly observable outcomes, the efficient allocation is welfare improving with respect to the case where the agents can self insure only through borrowing and lending. We identify the main sources of welfare improvement, and we compute substantial efficiency gains. We provide a tractable recursive framework to study the optimal allocation in this setting. The dynamic programming formulation is based on a generalized first order approach, whose validity is verified ex post, using a parsimonious numerical procedure based on the recursive formulation itself.

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Paper provided by Duke University, Department of Economics in its series Working Papers with number 04-05.

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Length: 69 pages
Date of creation: 2004
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Handle: RePEc:duk:dukeec:04-05

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Related research
Keywords: Moral hazard; hidden savings; social insurance; first order approach; recursive contracts; ex-post verification;

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Find related papers by JEL classification:
C61 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - Optimization Techniques; Programming Models; Dynamic Analysis
D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information
E21 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Noah Williams, 2004. "On Dynamic Principal-Agent Problems in Continuous Time," Levine's Bibliography 122247000000000426, UCLA Department of Economics. [Downloadable!]
  2. Orazio Attanasio & Nicola Pavoni, 2007. "Risk Sharing in Private Information Models with Asset Accumulation: Explaining the Excess Smoothness of Consumption," NBER Working Papers 12994, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  3. Marek Kapicka, 2006. "Optimal Income Taxation with Human Capital Accumulation and Limited Record Keeping," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(4), pages 612-639, October. [Downloadable!] (restricted)
  4. Mikhail Golosov & Aleh Tsyvinski, 2004. "Designing Optimal Disability Insurance: A Case for Asset Testing," NBER Working Papers 10792, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  5. Mikhail Golosov & Aleh Tsyvinski, 2006. "Optimal Taxation with Endogenous Insurance Markets," Levine's Bibliography 784828000000000445, UCLA Department of Economics. [Downloadable!]
    Other versions:
  6. Pavoni, Nicola & Violante, Giovanni L, 2006. "Optimal Welfare-to-Work Programs," CEPR Discussion Papers 5937, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  7. Arpad Abraham & Nicola Pavoni, 2008. "Efficient Allocations with Moral Hazard and Hidden Borrowing and Lending: A Recursive Formulation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(4), pages 781-803, October. [Downloadable!] (restricted)
    Other versions:
  8. Arantxa Jarque, 2008. "Repeated moral hazard with effort persistence," Working Paper 08-04, Federal Reserve Bank of Richmond. [Downloadable!]
    Other versions:
  9. Matthias Messner & Nicola Pavoni, 2004. "On the Recursive Saddle Point Method," Levine's Bibliography 122247000000000050, UCLA Department of Economics. [Downloadable!]
    Other versions:
  10. Carlos E. da Costa & Lucas Maestri, 2005. "The Interaction Between Unemployment Insurance And Human Capital Policies," Anais do XXXIII Encontro Nacional de Economia [Proceedings of the 33th Brazilian Economics Meeting] 089, ANPEC - Associação Nacional dos Centros de Pósgraduação em Economia [Brazilian Association of Graduate Programs in Economics]. [Downloadable!]
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  11. Noah Williams, 2008. "Persistent Private Information," NBER Working Papers 13894, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  12. Narayana Kocherlakota, 2004. "Figuring out the Impact of Hidden Savings on Optimal Unemployment Insurance," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(3), pages 541-554, July. [Downloadable!] (restricted)
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