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Why Does it Matter that Beliefs and Valuations be Correctly Represented?

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  • Grant, S.

    (Tilburg University, Center For Economic Research)

  • Karni, E.

Abstract

This article contains an analysis of a simple principal-agent problem illustrating possible problems that may arise when the prinicpal ascribes to the agent subjective probabilities and utilities that are implied by the subjective expected utility model but do not represent the agent's beliefs and valuations. In particular, it is possible that an incentive contract designed by the principal induces the agent to choose an action that is not in the principal's best interest. Copyright 2005 by the Economics Department Of The University Of Pennsylvania And Osaka University Institute Of Social And Economic Research Association.
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Suggested Citation

  • Grant, S. & Karni, E., 2002. "Why Does it Matter that Beliefs and Valuations be Correctly Represented?," Discussion Paper 2002-12, Tilburg University, Center for Economic Research.
    • Handle: RePEc:tiu:tiucen:27a5efe4-2205-49cd-b879-55a983f8aa69
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    References listed on IDEAS

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    1. Paul M. Romer, 2000. "Thinking and Feeling," American Economic Review, American Economic Association, vol. 90(2), pages 439-443, May.
    2. Karni, Edi, 2003. "On the Representation of Beliefs by Probabilities," Journal of Risk and Uncertainty, Springer, vol. 26(1), pages 17-38, January.
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    6. Karni, Edi & Schmeidler, David, 1993. "On the Uniqueness of Subjective Probabilities," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 3(2), pages 267-277, April.
    7. George Loewenstein, 2000. "Emotions in Economic Theory and Economic Behavior," American Economic Review, American Economic Association, vol. 90(2), pages 426-432, May.
    8. Jon Elster, 1998. "Emotions and Economic Theory," Journal of Economic Literature, American Economic Association, vol. 36(1), pages 47-74, March.
    9. Bengt Holmstrom, 1979. "Moral Hazard and Observability," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 74-91, Spring.
    10. Karni, Edi, 1996. "Probabilities and Beliefs," Journal of Risk and Uncertainty, Springer, vol. 13(3), pages 249-262, November.
    11. Bengt Holmstrom, 1979. "Moral Hazard and Observability," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 74-91, Spring.
    12. Colin F. Camerer, 1997. "Progress in Behavioral Game Theory," Journal of Economic Perspectives, American Economic Association, vol. 11(4), pages 167-188, Fall.
    13. Grant, Simon & Karni, Edi, 2004. "A theory of quantifiable beliefs," Journal of Mathematical Economics, Elsevier, vol. 40(5), pages 515-546, August.
    14. Karni, Edi & Postlewaite, Andrew, 2005. "David Schmeidler," Games and Economic Behavior, Elsevier, vol. 50(1), pages 1-2, January.
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    Cited by:

    1. ,, 2013. "Contingent preference for flexibility: eliciting beliefs from behavior," Theoretical Economics, Econometric Society, vol. 8(2), May.
    2. Philipp Sadowski, 2011. "Contingent Preference for Flexibility: Eliciting Beliefs from Behavior," Levine's Working Paper Archive 661465000000001189, David K. Levine.
    3. David Dillenberger & Andrew Postlewaite & Kareen Rozen, 2011. "Optimism and Pessimism with Expected Utility, Third Version," PIER Working Paper Archive 13-001, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 26 Dec 2012.
    4. Marie-Louise Vierø, 2012. "Contracting in Vague Environments," American Economic Journal: Microeconomics, American Economic Association, vol. 4(2), pages 104-130, May.
    5. David Dillenberger & Andrew Postlewaite & Kareen Rozen, 2013. "Optimism and Pessimism with Expected Utility, Fifth Version," PIER Working Paper Archive 15-009, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 23 Feb 2015.
    6. David Dillenberger & Andrew Postlewaite & Kareen Rozen, 2017. "Optimism and Pessimism with Expected Utility," Journal of the European Economic Association, European Economic Association, vol. 15(5), pages 1158-1175.
    7. Sadowski, Philipp, 2008. "Conditional Preference for Flexibility: Eliciting Beliefs from Behavior," MPRA Paper 8614, University Library of Munich, Germany.
    8. David Dillenberger & Andrew Postlewaite & Kareen Rozen, 2011. "Optimism and Pessimism with Expected Utility, Fourth Version," PIER Working Paper Archive 13-068, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 01 Nov 2013.
    9. David Dillenberger & Andrew Postlewaite & Kareen Rozen, 2011. "Optimism and Pessimism with Expected Utility, Second Version," PIER Working Paper Archive 12-031, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 10 Aug 2012.

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    More about this item

    Keywords

    principal agent theory; moral hazard;

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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