Moral hazard

Summary

In economics, a moral hazard is a situation where an economic actor has an incentive to increase its exposure to risk because it does not bear the full costs of that risk. For example, when a corporation is insured, it may take on higher risk knowing that its insurance will pay the associated costs. A moral hazard may occur where the actions of the risk-taking party change to the detriment of the cost-bearing party after a financial transaction has taken place. Moral hazard can occur under a type of information asymmetry where the risk-taking party to a transaction knows more about its intentions than the party paying the consequences of the risk and has a tendency or incentive to take on too much risk from the perspective of the party with less information. One example is a principal–agent approach (also called agency theory), where one party, called an agent, acts on behalf of another party, called the principal. However, principal-agent problem can occur when there is a conflict

Official source

https://en.wikipedia.org/wiki/Moral_hazard

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Short-term debt and incentives for risk-taking

Erwan Morellec, Francesca Maria Zucchi

We challenge the view that short-term debt curbs moral hazard and demonstrate that, in a world with financing frictions and fair debt pricing, short-term debt generates incentives for risk-taking. To do so, we develop a model in which firms are financed with equity and short-term debt and cannot freely optimize their default decision because of financing frictions. We show that when firms are close to distress, the dynamic interaction of operating and rollover losses fuels default risk. In such instances, shareholders find it optimal to increase asset risk to improve interim debt repricing and prevent inefficient liquidation. These risk-taking incentives do not arise when debt maturity is sufficiently long. (C) 2020 Elsevier B.V. All rights reserved.

ELSEVIER SCIENCE SA2020

Collaborative Housing and the Intermediation of Moral Hazard

Thomas Alois Weber

This paper considers intermediation in a di_erentiated short-term housing market where heterogeneous agents may stay at a hotel or at one of several private hosts' properties, below or above hotel quality. The collaborative-housing market fails when agents' hidden actions are noncontractable. If expected liability is not excessive, a trusted intermediary can induce agents to exert first-best effort and fully insure the hosts' risks, without subsidizing the transactions. The intermediary can also extract the hosts' surplus if their outside option is zero; somewhat counter-intuitively, the commission on either side of the transactions does not affect agents' equilibrium payoffs. The optimal commission structure makes direct transactions between hosts and renters unattractive.

EPFL CDM MTEI2013

Electronic intermediaries have become pervasive in sales transactions for many durables, such as cars, power tools, and apartments. Yet only recently have they successfully tackled the challenge of enabling parties to share such goods. A key impediment to sharing is a lender’s concern about damage due to unobservable actions by a renter, usually resulting in moral hazard. This paper shows how an intermediary can eliminate the moral-hazard problem by providing optimal insurance to the lender and first-best-incentives to the renter to exert care, as long as market participants are risk-neutral. The solution is illustrated for the collaborative housing market but applies in principle to any sharing market with vertically differentiated goods. A population of renters, heterogeneous both in their preferences for housing quality and with respect to the amounts of care they exert in a rental situation, faces a choice between collaborative housing and staying at a local hotel. The private hosts choose their prices strategically and the intermediary sets commission rates on both sides of the market as well as insurance terms for the rental agreement. The latter are set so as to eliminate moral hazard. The intermediary is able to extract the gains the hosts would earn compared to transacting directly. Finally, even if hotels set their prices at the outset so as to maximize collusive profits, we find that collaborative housing persists at substantial market shares, regardless of the difference between the efficiencies of hosts and hotels to reduce renters’ cost of effort. The aggregate of hosts, intermediary, and hotels benefits from a variety in these effort costs, which indicates that the intermediated sharing of goods is an economically viable, robust phenomenon.

Routledge Journals, Taylor & Francis Ltd2014