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Optimal contracts in continuous-time models

Author

Listed:
  • Jakša Cvitanić
  • Xuhu Wan
  • Jianfeng Zhang

Abstract

We present a unified approach to solving contracting problems with full information in models driven by Brownian motion. We apply the stochastic maximum principle to give necessary and sufficient conditions for contracts that implement the so-called first-best solution. The optimal contract is proportional to the difference between the underlying process controlled by the agent and a stochastic, state-contingent benchmark. Our methodology covers a number of frameworks considered in the existing literature. The main finance applications of this theory are optimal compensation of company executives and of portfolio managers.

Suggested Citation

  • Jakša Cvitanić & Xuhu Wan & Jianfeng Zhang, 2006. "Optimal contracts in continuous-time models," International Journal of Stochastic Analysis, Hindawi, vol. 2006, pages 1-27, July.
    • Handle: RePEc:hin:jnijsa:095203
    DOI: 10.1155/JAMSA/2006/95203
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    Cited by:

    1. Thibaut Mastrolia & Dylan Possamaï, 2018. "Moral Hazard Under Ambiguity," Journal of Optimization Theory and Applications, Springer, vol. 179(2), pages 452-500, November.
    2. Emma Hubert, 2020. "Continuous-time incentives in hierarchies," Papers 2007.10758, arXiv.org.
    3. Jessica Martin & Stéphane Villeneuve, 2023. "Risk-sharing and optimal contracts with large exogenous risks," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 46(1), pages 1-43, June.
    4. Jessica Martin & Stéphane Villeneuve, 2023. "Risk-sharing and optimal contracts with large exogenous risks," Post-Print hal-04164688, HAL.
    5. Dylan Possamai & Nizar Touzi, 2020. "Is there a Golden Parachute in Sannikov's principal-agent problem?," Papers 2007.05529, arXiv.org, revised Oct 2022.

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