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16:30 | Micro Theory Research Seminar
“Contracts and Markets: Risk Sharing with Hidden Types”
Abstract: I study two-way effects between financial markets and contractual agreements, such as compensation packages within a firm, or mortgages and loans. I construct a model with many Units, in each of which one of the contracting individuals, the Agent, has private information, while the uninformed individual, the Principal, has the opportunity to trade with the Principals in other Units. I give general conditions under which financial markets induce a transfer of risk from Agents to Principals. These conditions can be reduced to a limited degree of correlation among Units' returns. I show, under the same conditions, that markets induce a transfer of welfare from the best Agents to Principals. Conversely, the information asymmetry within Units leads to excessive aggregate risk in the asset market. However, this problem vanishes in a large economy.
Full Text: “Contracts and Markets: Risk Sharing with Hidden Types”
