ECON 704 Midterm: PrelimB 2012_Cole_704_Fall
Document Summary
1 optimal insurance and e ort with an outside. Parts of this problem are novel and challenging, but the (cid:133)rst part is pretty standard. So, be careful to get the (cid:133)rst part right and to think a bit in doing the second two. Consider the following 3 period model with enforcement issues. Time is discrete and indexed by t = 0; 1; 2: the (cid:133)rst period, t = 0; is the ex ante contracting period. There is a single risk-neutral principal who wants to insure an agent against his stochastic productivity opportunities in periods t = 1 and t = 2. If the agent does not choose the outside option his continuation payo in period t is given by. Vt = u((cid:18)tlt + (cid:28) t) (cid:0) v((cid:18)tlt) + (cid:12)evt+1; where (cid:28) t is the state-contingent transfer under the insurance contract.
