Contracting under asymmetric information and asymmetric awareness

Abstract

I study a principal-agent contracting problem in which problems of asymmetric information and asymmetric awareness are present. I consider an insurance situation in which two types of agents know only a subset of the possible contingencies leading to damage over some good. The insurer is fully aware. However the insurer does not know which contingencies the insuree is originally aware of. The model is reduced to study the case of two types and three states or contingencies. A type who becomes aware of a contingency updates his awareness by assigning some residual probability to that event. The principal has the choice of which contingencies to cover, along with how to structure the terms of his contract to appeal to the various types. I hypothesize that the distribution of types of agents, updating parameters and levels of suspicion has an eect on the terms of the optimal contract. First a general solution method of the optimization problem of the principal is oered together with general characterizations of solutions. It is shown that certain distributions of types induce the principal to reveal information out of self interest, thereby altering the awareness of the dierent types of insurees and inducing more complete contracts.