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Contracting Under Incomplete Information

In: Contract Theory: Discrete- and Continuous-Time Models

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  • Jaeyoung Sung

    (Ajou University)

Abstract

In this chapter, we extend the complete information case of Chap. 5 to that of incomplete information by using the Kalman–Bucy filteringKalman–Bucy filter method, and we study effects of learningLearning on the optimal contract. In particular, we examine two cases: (1) a parameter is an unknown constant and (2) it is an unknown BM process with a linear drift. The first case extends the Holmström–Milgrom model by allowing the information about the unknown parameter to be updated over time. We show that the updating introduces a drift risk to the outcome and that the two parties optimally share not only the (conditional) outcome risk, but also the (unconditional) drift risk. However, if the principalSecond best, risk-based continuous time incomplete information Incomplete information is risk neutral, sheContinuous-time contracting models incomplete information takes all alone the drift risk, and the sensitivity of the contract remains unchanged from that of the Holmström–Milgrom case. The second case confirms the same conclusion for the risk-neutral principal.

Suggested Citation

  • Jaeyoung Sung, 2023. "Contracting Under Incomplete Information," Springer Books, in: Contract Theory: Discrete- and Continuous-Time Models, chapter 0, pages 113-122, Springer.
    • Handle: RePEc:spr:sprchp:978-981-99-5487-2_7
    DOI: 10.1007/978-981-99-5487-2_7
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