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Permalink: http://hdl.handle.net/1866/8861

Contracting for innovation under knightian uncertainty

Article [Version of Record]
Thumbnail
2012-15-cah.pdf (375.8Kb)
Is part of
Cahier de recherche ; no. 2012-15.
Publisher(s)
Université de Montréal. Département de sciences économiques.
2012-09
Author(s)
Amarante, Massimiliano
Ghossoub, Mario
Phelps, Edmund
Affiliation
  • Université de Montréal. Faculté des arts et des sciences. Département de sciences économiques
Keywords
  • Innovation
  • Entrepreneurship
  • Knightian uncertanity
  • Ambiguity
  • Contracting
  • Vigilance
  • Insurance
Abstract(s)
At any given point in time, the collection of assets existing in the economy is observable. Each asset is a function of a set of contingencies. The union taken over all assets of these contingencies is what we call the set of publicly known states. An innovation is a set of states that are not publicly known along with an asset (in a broad sense) that pays contingent on those states. The creator of an innovation is an entrepreneur. He is represented by a probability measure on the set of new states. All other agents perceive the innovation as ambiguous: each of them is represented by a set of probabilities on the new states. The agents in the economy are classified with respect to their attitude towards this Ambiguity: the financiers are (locally) Ambiguity-seeking while the consumers are Ambiguity-averse. An entrepreneur and a financier come together when the former seeks funds to implement his project and the latter seeks new profit opportunities. The resulting contracting problem does not fall within the standard theory due to the presence of Ambiguity (on the financier’s side) and to the heterogeneity in the parties’ beliefs. We prove existence and monotonicity (i.e., truthful revelation) of an optimal contract. We characterize such a contract under the additional assumption that the financiers are globally Ambiguity-seeking. Finally, we re-formulate our results in an insurance framework and extend the classical result of Arrow [4] and the more recent one of Ghossoub. In the case of an Ambiguity-averse insurer, we also show that an optimal contract has the form of a generalized deductible.
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  • Faculté des arts et des sciences – Département de sciences économiques - Travaux et publications [552]

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