Moral Hazard and Linear Contracts: Economies with Idiosyncratic Risks
Résumé
In exchange economies where moral hazard affects the distribution of individual risks, we study the viability of linear nonexclusive contracts. It is shown that the linearity in prices and payoffs is compatible with the presence of moral hazard when coupled with a simple taxation scheme. More specifically, we prove existence of competitive equilibrium. The taxation scheme can be seen as a form of sharing the profits and losses in a mutual insurance arrangement. The contracts can be given the more general interpretation of financial assets in markets where the unverifiability of trades is widespread. The asset prices are such that hedging opportunities may be 'incomplete' at equilibrium.