Optimal Long-term Contracts with Limited Commitment and Unobservable Disability

57 Pages Posted: 18 Jul 2019 Last revised: 29 Jan 2021

See all articles by Kyoung Jin Choi

Kyoung Jin Choi

University of Calgary - Haskayne School of Business

Junkee Jeon

Kyung Hee University - Department of Applied Mathematics

Ho-Seok Lee

Kwangwoon University - Department of Mathematics

Hsuan-Chih Lin

Academia Sinica - Institute of Economics

Date Written: January 28, 2021

Abstract

We study a continuous-time model of an optimal long-term labor contract that has disability benefits under two frictions: the agent cannot commit to a long-term contract and the disability shock is private information. We provide a novel solution method and investigate how the two frictions affect the optimal contract. We find that the optimal contract can be implemented under a three-account trading system in which mandatory savings should often be imposed to discourage the agent from falsely claiming disability. Finally, our quantitative analysis shows that the cost caused by current long-term disability insurance practice can be substantial.

Keywords: Dynamic Contracting, Disability Insurance, Limited Commitment, Truth-Telling

JEL Classification: C61, D47, D82, D86, E21, I13

Suggested Citation

Choi, Kyoung Jin and Jeon, Junkee and Lee, Ho-Seok and Lin, Hsuan-Chih, Optimal Long-term Contracts with Limited Commitment and Unobservable Disability (January 28, 2021). Available at SSRN: https://ssrn.com/abstract=3421296 or http://dx.doi.org/10.2139/ssrn.3421296

Kyoung Jin Choi (Contact Author)

University of Calgary - Haskayne School of Business ( email )

2500 University Drive, NW
Calgary, Alberta T2N 1N4
Canada

HOME PAGE: http://sites.google.com/site/kyoungjinchoiecon/

Junkee Jeon

Kyung Hee University - Department of Applied Mathematics ( email )

1732 Deogyeong-daero, Giheung-gu,
Yongin, 130-701
Korea, Republic of (South Korea)

Ho-Seok Lee

Kwangwoon University - Department of Mathematics ( email )

20 Kwangwoon-ro, Nowon-gu
Seoul, 01897
Korea, Republic of (South Korea)

Hsuan-Chih Lin

Academia Sinica - Institute of Economics ( email )

128 Academia Road, Section 2
Nankang
Taipei, 11529
Taiwan

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