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Economic Quarterly

Winter 1999

A Primer on Moral-Hazard Models

Edward S. Prescott

Economists regularly consider moral hazard when they analyze topics like insurance contracts, labor compensation, and financial regulation. The primer provided here describes moral hazard, its implications, and how to model it. The modeling strategy is to allow randomization in the contractual terms, formulate the contracting problem as a linear program, and then compute solutions to examples. The technique is illustrated with a bank regulation example.

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