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Lecture 6 Uncertainty. Cost of Risk Agents are said to be risk averse if they prefer the expected payoff from a gamble to the gamble itself.

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Presentation on theme: "Lecture 6 Uncertainty. Cost of Risk Agents are said to be risk averse if they prefer the expected payoff from a gamble to the gamble itself."— Presentation transcript:

1 Lecture 6 Uncertainty

2 Cost of Risk Agents are said to be risk averse if they prefer the expected payoff from a gamble to the gamble itself

3 Since most agents are risk averse we see the existence of economic institutions and arrangements such as: –Insurance contracts –Wage contracts –Futures contracts –Warranties

4 Asymmetric Information Uncertainty arises because one agent has more information or better information than another When information is asymmetric two problems can arise: -adverse selection -moral hazard

5 Adverse Selection One party doesn’t know something about the other party’s characteristics -Agents enter into agreements in which they use their private information about their characteristics to their own advantage

6 Moral Hazard One party doesn’t know something about the other party’s actions (behaviour) -After agreement between agents, one agent has incentive to act in a way that brings additional benefit to himself at the expense of the other


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