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Risk aversion and incentive compatibility with ex post information asymmetry

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Summary.

The paper extends Diamond's (1984) analysis of financial contracting with information asymmetry ex post and endogenous “bankruptcy penalties” to allow for risk aversion of the borrower. The optimality of debt contracts, which Diamond obtained for the case of risk neutrality, is shown to be nonrobust to the introduction of risk aversion. This contrasts with the costly state verification literature, in which debt contracts are optimal for risk averse as well as risk neutral borrowers.

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Authors and Affiliations

  1. Fakultät für Volkswirtschaftslehre, Universität Mannheim, Seminargebäude A5, 68131 Mannheim, GERMANY (e-mail: hellwig@pool.uni-mannheim.de) , , , , , , DE

    Martin F. Hellwig

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  1. Martin F. Hellwig
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Received: December 7, 1998; revised version: June 9, 1999

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Hellwig, M. Risk aversion and incentive compatibility with ex post information asymmetry. Econ Theory 18, 415–438 (2001). https://doi.org/10.1007/PL00004192

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  • DOI: https://doi.org/10.1007/PL00004192

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