Incorporating Unawareness into Contract Theory
Abstract
Asymmetric awareness of the contracting parties regarding the uncertainty surrounding them is proposed as a reason for incompleteness in contractual forms. An insurance problem is studied between a risk neutral insurer, who has superior awareness regarding the nature of the uncertainty, and a risk averse insuree, who cannot foresee all the relevant contingencies. The insurer can mention in a contract some contingencies that the insuree was originally unaware of. It is shown that there are equilibria where the insurer strategically offers incomplete contracts. Next, equilibrium contracts are fully characterized for the case where the insuree is ambiguity averse and holds multiple beliefs when her awareness is extended. Competition among insurers who are symmetrically aware of the uncertainty promotes awareness of the insuree.
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