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Risky utilities

Author

Listed:
  • Jean-Charles Rochet

    (University of Zürich
    SFI
    TSE (IDEI))

  • Guillaume Roger

    (University of Sydney)

Abstract

We develop a theory of “risky utilities,” i.e., private firms that manage an infrastructure for public service and that may be tempted to engage in excessively risky activities, such as reducing maintenance expenditures (at the risk of provoking a breakdown of the system) or in speculation (at the risk of incurring massive losses it cannot bear). These risky utilities include financial utilities like exchanges, clearinghouses or payment systems, as well as standard utilities like electricity transmission networks. Continuation of service is essential, so risky utilities cannot be liquidated. The optimal regulatory contract minimizes the social cost among the contracts that steer the firm away from risky activities. It is simple and implemented with a capital (equity) adequacy requirement and a resolution mechanism when that requirement is breached. The social cost function is explicitly computed, and comparative statics can be simply derived.

Suggested Citation

  • Jean-Charles Rochet & Guillaume Roger, 2016. "Risky utilities," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 62(1), pages 361-382, June.
    • Handle: RePEc:spr:joecth:v:62:y:2016:i:1:d:10.1007_s00199-015-0919-2
    DOI: 10.1007/s00199-015-0919-2
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    References listed on IDEAS

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    Cited by:

    1. Viral V. Acharya & Aaditya M. Iyer & Rangarajan K. Sundaram, 2020. "Risk-Sharing and the Creation of Systemic Risk," JRFM, MDPI, vol. 13(8), pages 1-38, August.
    2. Tak-Yuen Wong, 2019. "Dynamic Agency and Endogenous Risk-Taking," Management Science, INFORMS, vol. 65(9), pages 4032-4048, September.

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    More about this item

    Keywords

    Moral hazard; Dynamic contract; Speculation; Capital requirements;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • L43 - Industrial Organization - - Antitrust Issues and Policies - - - Legal Monopolies and Regulation or Deregulation

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