ECON 704 Midterm: PrelimA 2012-1_704Cole
Document Summary
Cole(cid:146)s problem prelim exam june 2012: consider the following optimal insurance problem. Assume that we have a set of households who each receive a constant income stream of y. Each household receives a stochastic taste shock f(cid:18)tg1 t=0; and has preferences given by. We will assume that these households enter into a (cid:133)nancial contract with an agent who can borrow and save at a (cid:133)xed per-period interest rate r = (cid:12)(cid:0)1; and therefore has objective function. A contract is a sequence of functions fftg : ct = ft(ht): explain why we can use the type space as the message space for the contract and focus on truthtelling contracts. Show the extra "incentive con- straint" that we need to impose, and explain how we can replace this single complicated constraint with a series of constraints in which only a one-shot lie is contemplated.
