Optimal Risk Sharing with Limited Liability

ABSTRACT: Disclosure and monitoring policy are studied, where disclosure relates to information about the monitoring system. A moral hazard model is presented where employee monitoring occurs with some exogenous probability and the owner privately learns whether he will be monitoring before the employee chooses his productive action. Disclosure policy is an owner choice between revealing to the employee whether he will be monitoring before the action (Disclosure) or remaining silent (Secrecy). The results rely on the joint presence of risk aversion and limited liability. Risk aversion creates an efficiency/risk tradeoff where secrecy obtains risk-sharing benefits. Limited liability reduces these benefits, allowing preference for disclosure. Lower monitoring probabilities increase the risk premium required to obtain effort with secrecy. For small monitoring probabilities, disclosure is preferred even though less efficient production is achieved, because disclosure provides a greater risk-sharing benefit. For high monitoring probabilities, secrecy is preferred because it leads to greater efficiency despite a greater risk premium.

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Optimal Risk Sharing in the Trenches

Journal of Political Economy ◽

10.1086/373885 ◽

2003 ◽

Vol 111 (2) ◽

pp. Back Cover-Back Cover

Keyword(s):

Risk Sharing ◽

Optimal Risk Sharing

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Optimal Risk Sharing

Encyclopedia of Actuarial Science ◽

10.1002/9780470012505.tar042 ◽

2004 ◽

Cited By ~ 2

Author(s):

Knut K. Aase

Keyword(s):

Risk Sharing ◽

Optimal Risk Sharing

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Optimal Risk Sharing

Wiley StatsRef: Statistics Reference Online ◽

10.1002/9781118445112.stat04681 ◽

2014 ◽

Author(s):

Knut K. Aase

Keyword(s):

Risk Sharing ◽

Optimal Risk Sharing

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Experimental Stock Markets with Controlled Risk Preferences

Journal of Accounting Auditing & Finance ◽

10.1177/0148558x9200700201 ◽

1992 ◽

Vol 7 (2) ◽

pp. 117-134 ◽

Cited By ~ 2

Author(s):

John R. O'Brien

Keyword(s):

Risk Sharing ◽

Competitive Equilibrium ◽

Risk Preferences ◽

World Market ◽

Equilibrium Price ◽

Double Auction ◽

Pareto Optimal ◽

Market Institution ◽

Certainty Equivalents ◽

Optimal Risk Sharing

In this paper the empirical validity of the binary lottery preference inducing technique is tested in a real world market institution. In each market the potential gains to exchange arise from induced risk preferences, and the predicted competitive equilibrium is equivalent to the Pareto optimal risk sharing allocation. Price convergence to (and near) the competitive equilibrium price was rapid in each market, and most trades were individually rational with respect to induced certainty equivalents. This evidence implies that preferences can be induced in an oral double auction institution, using this technique.

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