Dynamic costly state verification (Q813234)

The paper deals with a model of dynamic risk sharing with costly state verification (say CSV), particularly interesting because of its applications to topics involving investment contracting, banking, macroeconomics. The problem treated in the paper consists of optimal dynamic contracting between a risk neutral agent and a risk averse agent. In each period, the risk averse agent receives a random income observed directly only by himself. On the other side, the risk neutral agent observes the risk averse agent's income realization by paying a fixed deterministic monitoring cost. The author fronts the problem considering, as a starting point, the case of CARA utility function; in particular in the case of two income levels, the structure of the optimal contract is quite completely expressed, whilst in the case of more than two income levels, this characterization is less complete. Successively the case of a non-CARA utility function is analysed; in this context a numerical example involving a log utility is developed and the optimality condition is expressed as a function of the risk averse agent's expected utility.