Robust Moral Hazard with Distributional Ambiguity

Zhaolin Li

No BAWP-2020-03, Working Papers from University of Sydney Business School, Discipline of Business Analytics

Abstract: We present a moral hazard model in which both the entrepreneur and investor face limited liability and employ a robust decision rule that maximizes their worst-case expected profit when distributional ambiguity exists. Applying strong duality, we reformulate the robust moral hazard model by introducing a new set of incentive compatibility constraints associated with choosing the most unfavourable distribution. We develop a one-step-ahead method using shadow prices for such probabilistic resources as mean and variance to characterize the robustly optimal contract and to improve the commonly used debt contract.

Keywords: Debt contract; Moral hazard; Robust optimization (search for similar items in EconPapers)
Date: 2020-10-14
New Economics Papers: this item is included in nep-cta and nep-mic
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:syb:wpbsba:2123/23549

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