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Communication in Private-Information Models: Theory and Computation

Edward Prescott ()

The Geneva Risk and Insurance Review, 2003, vol. 28, issue 2, 105-130

Abstract: Communication and no-communication versions of a two-stage principal-agent model are compared. The models contain a risk-averse agent and two sources of private information, a shock to preferences followed by a productive action. Both models are formulated as linear programs, which are then used to compute solutions to examples. For the communication model, an alternative method of accounting for the utility from off-equilibrium strategies is derived. This method greatly reduces the size of the linear program. For the no-communication model a Revelation-Principle like proof is provided. In simple cases, a sufficient condition for communication to be valuable is derived. In these cases, communication improves risk-sharing in bad states of the world. In more complicated cases, computed examples demonstrate how communication may also alter labor supply. Further examples demonstrate how action and consumption lotteries may separate agents by their shock. The Geneva Papers on Risk and Insurance Theory (2003) 28, 105–130. doi:10.1023/A:1026388604459

Date: 2003
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