Lost in Translation: Honest Misunderstandings and Ex Post Disputes

We give a formal treatment of optimal risk sharing contracts in the face of ambiguity. The central idea is that boundedly rational individuals do not have access to a language sufficiently rich to describe all possible states of nature. The ambiguity in a contract arises from contractual clauses that are interpreted by the parties in different ways. The cost of ambiguity is represented in terms of dispute costs. Taking the potential for dispute into account, we find that risk averse agents may forgo potential gains from risk sharing and choose incomplete contracts instead.


Issue Date:
Aug 10 2006
Publication Type:
Working or Discussion Paper
PURL Identifier:
http://purl.umn.edu/151177
Total Pages:
25
JEL Codes:
D80; D82
Series Statement:
Risk and Uncertainty Program
R06/3




 Record created 2017-04-01, last modified 2017-10-18

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