Adverse Selection, Risk Sharing and Business Cycles

Abstract

I consider a real business cycle model in which agents have private information about an idiosyncratic shock to their value of leisure. I consider the mechanism design problem for this economy and describe a computational method to solve it. This is an important contribution of the paper since the method could be used to solve a wide class of models with heterogeneous agents and aggregate uncertainty. Calibrating the model to U.S. data I find a striking result: That the information frictions that plague the economy have no effects on business cycle fluctuations.

Keywords: Adverse selection, risk sharing, business cycles, private information, incentives, optimal contracts, computational methods, heterogeneous agents

JEL Classification: C63, C68, D31, D82, E32