Moral hazard and nominal, linear contracts

Archishman Chakraborty and Alessandro Citanna

GSIA Working Papers from Carnegie Mellon University, Tepper School of Business

Abstract: We study competitive equilibria with moral hazard in economies with aggregate risk and where trading occurs with an incomplete set of financial assets (this version preliminarly analyzes economies with trading in only one asset). The main conclusion of the paper is that, contrary to the individual risk economies, moral hazard is compatible with trading in competitive linear financial contracts, and gives rise to no manipulation problem. We establish existence of nonmanipulable equilibria provided that there are no relative price effects (e.g. a one-commodity economy), and that financial markets are sufficiently incomplete.

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