SMU SOE Seminar (Mar 22, 2017): Recursive CARA Preferences and Contracting under Ambiguity

We present a decision-theoretic model of ambiguity in an interpersonal context. Individuals receive information about the world directly, through observation of signals, and indirectly through signals observed by others. Information about one’s own signal is unambiguous, while information about another’s signal is ambiguous. We model this situation using two-stage recursive constant absolute risk aversion (CARA) preferences. We apply the model to a principal—agent problem to determine the form of optimal contracting in the presence of ambiguity and risk.

Keywords: Ambiguity, principal-agent problem, state-contingent versus output contingent contracts

JEL Classification: D80, D82

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