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American Economic Review

ISSN 0002-8282 (Print) | ISSN 1944-7981 (Online)

Disentangling Moral Hazard and Adverse Selection

  • Henrique Castro-Pires
  • Hector Chade
  • Jeroen Swinkels
American Economic Review
vol. 114, no. 1, January 2024
(pp. 1–37)
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Abstract

While many real-world principal-agent problems have both moral hazard and adverse selection, existing tools largely analyze only one at a time. Do the insights from the separate analyses survive when the frictions are combined? We develop a simple method—decoupling—to study both problems at once. When decoupling works, everything we know from the separate analyses carries over, but interesting interactions also arise. We provide simple tests for whether decoupling is valid. We develop and numerically implement an algorithm to calculate the decoupled solution and check its validity. We also provide primitives for decoupling to work and analyze several extensions.

Citation

Castro-Pires, Henrique, Hector Chade, and Jeroen Swinkels. 2024. "Disentangling Moral Hazard and Adverse Selection." American Economic Review, 114 (1): 1–37. DOI: 10.1257/aer.20220100

Additional Materials

JEL Classification

  • D82 Asymmetric and Private Information; Mechanism Design
  • D86 Economics of Contract: Theory