The Trade-Off Between Incentives and Endogenous Risk

Aloisio Araujo, Humberto Moreira and Marcos Tsuchida

Brazilian Review of Econometrics, 2007, vol. 27, issue 2

Abstract: Negative relationship between risk and incentives, predicted by standard moral hazard models, has not been confirmed by empirical work. We propose a moral hazard model in which heterogeneous risk-averse agents can control the mean and variance of the profits. The possibility of risk reduction allows the agent’s marginal utility of incentives to be increasing or decreasing in risk aversion. Positive relationship between endogenous risk and incentives is found when marginal utility of incentives and variance are decreasing in risk aversion. Exogenous risk and incentives are negatively related. Those results remain when adverse selection precedes moral hazard.

Date: 2007
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Related works:
Working Paper: The trade-off between incentives and endogenous risk (2004)
Working Paper: The trade-off between incentives and endogenous risk (2004)
Working Paper: The trade-off between incentives and endogenous risk (2004)
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Persistent link: https://EconPapers.repec.org/RePEc:sbe:breart:v:27:y:2007:i:2:a:1524

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