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Optimal Contracts under Costly State Falsification
Abstract
We examine an exchange economy with two agents: one risk neutral with a certain endowment and a second risk averse with a random endowment. The realization of the endowment is public but can be falsified by the second agent at a cost. For a broad class of falsification cost functions the optimal no-falsification contract is noncontingent on a left-hand interval and strictly increasing with a slope strictly less than one on a right-hand interval. Under a mild further restriction, optimal no-falsification contracts are, in addition, piece-wise linear. Optimal contracts may in general require falsifying the state, but for a set of the highest endowment realizations there is no falsification. We find simple conditions under which the optimal contract is a no-falsification contract. The model has applications that include financial, insurance, and employment contracts and tax policy.
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Cites
Optimal contracts and competitive markets with costly state verification
Townsend, R. M. (1979) · Journal of Economic Theory · doi:10.1016/0022-0531(79)90031-0 · Cited by 3,204
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Metadata
- Authors
- Lacker, J. M., & Weinberg, J. A.
- Venue
- Journal of Political Economy
- Publisher
- University of Chicago Press
- Published
- 1989-12
- Volume
- 97
- Issue
- 6
- Pages
- 1345-1363
- ISSN
- 0022-3808 (ISSN-L)
- 1537-534X
- OpenAlex
- W1979131559
- Cited by
- 266
- References
- 1
- FWCI
- 5.27
- Type
- journal article
- Language
- en
- Open access
- closed
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- Lacker, J. M., & Weinberg, J. A. (1989). Optimal Contracts under Costly State Falsification. Journal of Political Economy. https://doi.org/10.1086/261657
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