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Optimal contracting with moral hazard and behavioral preferences

Chang, Hualei and Cvitanić, Jakša and Zhou, Xun Yu (2015) Optimal contracting with moral hazard and behavioral preferences. Journal of Mathematical Analysis and Applications, 428 (2). pp. 959-981. ISSN 0022-247X. doi:10.1016/j.jmaa.2015.03.027.

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We consider a continuous-time principal–agent model in which the agent's effort cannot be contracted upon, and both the principal and the agent may have non-standard, cumulative prospect theory type preferences. We find that the optimal contracts are likely to be “more nonlinear” than in the standard case with concave utility preferences. In the special case when the principal is risk-neutral, we show that she will offer a contract which effectively makes the agent less risk averse in the gain domain and less risk seeking in the loss domain, in order to align the agent's risk preference better with the principal's.

Item Type:Article
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Cvitanić, Jakša0000-0001-6651-3552
Additional Information:© 2015 Elsevier Inc. Received 16 August 2014, Available online 20 March 2015. The authors are indebted to Hanqing Jin for a discussion related to randomization, and to an anonymous referee for detailed comments that have led to an improved version of the paper.
Subject Keywords:Principal–agent problem; Cumulative prospect theory; Contracts; Moral hazard; Control; Backward stochastic differential equation
Issue or Number:2
Record Number:CaltechAUTHORS:20160108-095142845
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Official Citation:Hualei Chang, Jakša Cvitanić, Xun Yu Zhou, Optimal contracting with moral hazard and behavioral preferences, Journal of Mathematical Analysis and Applications, Volume 428, Issue 2, 15 August 2015, Pages 959-981, ISSN 0022-247X, (
Usage Policy:No commercial reproduction, distribution, display or performance rights in this work are provided.
ID Code:63489
Deposited On:08 Jan 2016 20:25
Last Modified:10 Nov 2021 23:17

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