Overconfidence and Renegotiation

29 Pages Posted: 23 Oct 2023

See all articles by Leonidas Enrique de la Rosa

Leonidas Enrique de la Rosa

Aarhus University - Department of Economics and Business Economics

Nikolaj Niebuhr Lambertsen

Aarhus University - Department of Economics and Business Economics

Abstract

We study the implications of heterogeneous beliefs in a moral-hazard setting without commitment. Lack of commitment is costly because the principal cannot commit to not offering the optimal risk-sharing contract after the agent exerts effort, leading to the impossibility of implementing costly effort as a pure strategy when the principal and the agent have homogeneous beliefs. With heterogeneous beliefs, the optimal risk-sharing contract varies with the outcome, allowing costly effort levels to be implemented in pure strategies. With mixed-strategy implementation, we show that overconfidence improves the mixing equilibrium because it decreases the difference between the second-best contract and the optimal risk-sharing contract.

Keywords: Overconfidence, moral hazard, Renegotiation

Suggested Citation

de la Rosa, Leonidas Enrique and Lambertsen, Nikolaj Niebuhr, Overconfidence and Renegotiation. Available at SSRN: https://ssrn.com/abstract=4610371 or http://dx.doi.org/10.2139/ssrn.4610371

Leonidas Enrique De la Rosa

Aarhus University - Department of Economics and Business Economics ( email )

Fuglesangs Alle 4
Aarhus, 8210
Denmark

Nikolaj Niebuhr Lambertsen (Contact Author)

Aarhus University - Department of Economics and Business Economics ( email )

Fuglesangs Allé 4
Aarhus V, 8210
Denmark

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