Lost in Translation: Honest Misunderstandings and Ex Post Disputes Report as inadecuate




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We give a formal treatment of optimal risk sharing contracts in the face of ambiguity. The central idea is that boundedly rational individuals do not have access to a language sufficiently rich to describe all possible states of nature. The ambiguity in a contract arises from contractual clauses that are interpreted by the parties in different ways. The cost of ambiguity is represented in terms of dispute costs. Taking the potential for dispute into account, we find that risk averse agents may forgo potential gains from risk sharing and choose incomplete contracts instead.

Keywords: ambiguity ; bounded rationality ; incomplete contracts

Subject(s): Institutional and Behavioral Economics

Issue Date: Aug 10 2006

Publication Type: Working or Discussion Paper

PURL Identifier: http://purl.umn.edu/151177

Total Pages: 25

JEL Codes: D80; D82

Series Statement: Risk and Uncertainty Program

R06/3

Record appears in: University of Queensland > School of Economics > Risk and Sustainable Management Group Working Papers





Author: Grant, Simon ; Kline, Jeff ; Quiggin, John

Source: http://ageconsearch.umn.edu/record/151177?ln=en



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