Type Of Moral Hazard Research Articles

Optimal Cyber-Insurance Contract Design for Dynamic Risk Management and Mitigation

With the recent growing number of cyberattacks and the constant lack of effective defense methods, cyber risks have become ubiquitous in enterprise networks, manufacturing plants, and government computer systems. Cyber insurance provides a valuable approach to transfer the cyber risks to insurance companies and further improve the security status of the insured. The designation of effective cyber-insurance contracts requires considerations from both the insurance market and the dynamic properties of the cyber risks. To capture the interactions between the users and the insurers, we present a dynamic moral-hazard type of principal–agent model incorporated with Markov decision processes, which are used to capture the dynamics and correlations of the cyber risks as well as the user’s decisions on the protections. We study and fully analyze a case with a two-state two-action user under linear coverage insurance and further show the risk compensation, Peltzman effect, linear insurance contract principle, and zero-operating profit principle in this case. Numerical experiments are provided to verify our conclusions and further extend to cases of a four-state three-action user under linear coverage insurance and threshold coverage insurance.

Residential Housing Market and Bank Stability: Focusing on OECD and Emerging Asian Countries

In this study, we examine whether the fluctuation of residential housing prices affects the stability of financial institutions in 31 Organization for Economic Co-operation and Development (OECD) and emerging Asian countries. Utilizing 272,530 unique observations from 1990 to 2017, we explore effects of residential financing on bank stability mostly channeled by housing prices as a collateral effect, and by a type of moral hazard due to asymmetric information between borrowers and lenders. We first apply pooled mean group (PMG) estimators to isolate housing market price deviations from the market’s fundamental equilibrium, and then we conduct analysis using bank stability measures including return on assets (ROA,) and non-performing loan ratios (NPL). Results indicate that price deviation in the housing market from fundamental equilibrium is statistically significant for bank stability measures and persists in OECD countries over longer time horizons compared to emerging Asian countries. The findings also imply that loan growth represents a critical factor determining the level of bank stability while result from individual countries vary according to the relative maturity of their economy, level of interdependency between housing market and banking sector, and regulative environment for residential housing finance.

$\mathtt{FlipIn}$ : A Game-Theoretic Cyber Insurance Framework for Incentive-Compatible Cyber Risk Management of Internet of Things

Internet of Things (IoT) is highly vulnerable to emerging Advanced Persistent Threats (APTs) that are often operated by well-resourced adversaries. Achieving perfect security for IoT networks is often cost-prohibitive if not impossible. Cyber insurance is a valuable mechanism to mitigate cyber risks for IoT systems. In this work, we propose a bi-level game-theoretic framework called FlipIn to design incentive-compatible and welfare-maximizing cyber insurance contracts. The framework captures the strategic interactions among APT attackers, IoT defenders, and cyber insurance insurers, and incorporates influence networks to assess the systemic cyber risks of interconnected IoT devices. The FlipIn framework formulates a game over networks within a principal-agent problem of moral-hazard type to design a cyber risk-aware insurance contract. We completely characterize the equilibrium solutions of the bi-level games for a network of distributed defenders and a semi-homogeneous centralized defender and show that the optimal insurance contracts cover half of the defenders’ losses. Our framework predicts the risk compensation of defenders and the Peltzman effect of insurance. We study a centralized security management scenario and its decentralized counterpart, and leverage numerical experiments to show that network connectivity plays an important role in the security of the IoT devices and the insurability of both distributed and centralized defenders.

Non-Performing Loans of Commercial Banks in South Asian Countries: Adverse Selection and Moral Hazard Issues

In the South Asian region, a major cause of an increase in non-performing loans (NPL) is the bank’s adverse selection of borrowers. Using the GMM estimator, we empirically studied the bank-specific, industry specific and macroeconomic specific determinants of non-performing loans of banks in South Asian countries (Bangladesh, India, Nepal and Pakistan) from 1997 to 2012 and found that the adverse selection hypothesis of Stiglitz and Weiss (1981) was still effective. We found evidence for the bad luck, bad management, skimping and moral hazard hypotheses of Berger and DeYoung (1997) and their effect on the credit risk determination but we contributed to the literature by showing that ‘moral hazard type II’ (moral hazard between the bank management and the depositors) significantly affected the increase of non-performing loans. Bank size, industry concentration, inflation and GDP growth rate all significantly affected the sample countries’ non-performing loans. Empirical results showed a moderate degree of persistence of NPL and a late-hit of the global financial crisis in the region’s banking sector.

Preventive Repression: Two Types of Moral Hazard

Authoritarian leaders maintain their grip on power primarily through preventive repression, routinely exercised by specialized security agencies with the aim of preventing any opponents from organizing and threatening their power. We develop a formal model to analyze the moral hazard problems inherent in the principal-agent relationship between rulers and their security agents in charge of preventive repression. The model distinguishes two types of moral hazard: “politics,” through which the security agents can exert political influence to increase their payoff by decreasing the ruler’s rents from power, and “corruption,” through which the agents can increase their payoff by engaging in rent-seeking activities that do not decrease the ruler’s rents from power. The surprising conclusion is that both the ruler and the security agent are better off when the only moral hazard problem available is politics rather than when the agent can choose between politics and corruption. We also show that the equilibrium probability of ruler’s survival in power is higher when politics is the only moral hazard available to the agent. These findings lead to our central conclusion that opportunities for corruption undermine authoritarian rule by distorting the incentives of the security agencies tasked with preventing potential threats to an authoritarian ruler’s grip on power.

Types of moral hazard in health insurance marketing (Review Article)

Types of moral hazard in health insurance marketing (Review Article)

Equity, Debt and Moral Hazard: The Optimal Structure of Banks’ Loss Absorbing Capacity

This paper develops a model to analyse the optimal ex-ante capital and total loss absorbing capacity (TLAC) requirements, and the ex-post resolution policy of banks. Banks in our model are subject to two types of moral hazard: i) ex-ante, they have the incentive to shirk on project monitoring, thus increasing the risk of failure, and ii) ex-post, poorly capitalised banks have the incentive to engage in asset substitution by ‘gambling for resurrection’. Ex-ante moral hazard can be eliminated by ensuring that banks have sufficient capital and uninsured ‘bail-inable’ debt, while ex-post moral hazard is mitigated by triggering resolution when the minimum capital requirement is breached. We argue that optimal regulation consists of a high TLAC requirement and high capital buffer. Our analysis also suggests that higher system-wide risk would call for a higher capital buffer, but TLAC could be lowered if it does not jeopardise the credibility of bail-in itself.

Preventive Repression: Two Types of Moral Hazard

Authoritarian regimes maintain their grip on power primarily through preventive repression routinely exercised by specialized security agencies, with the aim of preventing any opposition from organizing and becoming public. We develop a formal model to analyze the moral hazard problems inherent in the principal-agent relationship between rulers and their security agents in charge of preventive repression. The model distinguishes two types of moral hazard: politics, by which the agents (security agencies) can exert political influence to increase their payoff by decreasing the ruler's payoff, and corruption, by which the agents can increase their payoff by engaging in rent-seeking activities that do not decrease the ruler's payoff. The surprising conclusion is that both the ruler and the security agent are better off when the only moral hazard problem available is politics rather than when the agent can choose between politics and corruption. We also show that the equilibrium probability of regime survival is higher when politics is the only moral hazard available to the agent. These findings lead to our central conclusion that opportunities for corruption undermine authoritarian regimes by distorting the incentives of the security agencies tasked with preventing domestic opposition.

Lobbying, political connections and emergency lending by the Federal Reserve

This paper tests whether the political connections of banks were important in explaining participation in the Federal Reserve’s emergency lending programs during the recent financial crisis. Our multivariate tests show that banks that were politically connected—either through lobbying efforts or employment of politically connected individuals—were substantially more likely to participate in the Federal Reserve’s emergency loan programs. In economic terms, participation in these programs was 28–36% more likely for banks that were politically connected than for banks that were not politically connected. In our final set of tests, we attempt to identify a proper explanation for this peculiar relationship. While a broad literature speaks of the moral hazard associated with receiving bailouts, we test whether another type of moral hazard exists in the period preceding the bailout. In particular, we argue that, to the extent that political connections act as synthetic insurance, banks may have engaged in more risky behavior that lead them to the Fed’s emergency lending facilities. Tests seem to confirm this explanation.

A Bi-Level Game Approach to Attack-Aware Cyber Insurance of Computer Networks

Cyber insurance is a valuable approach to mitigate further the cyber risk and its loss in addition to the deployment of technological cyber defense solutions, such as intrusion detection systems and firewalls. An effective cyber insurance policy can reduce the number of successful cyber attacks by incentivizing the adoption of preventative measures and the implementation of best practices of the users. To study cyber insurance in a holistic manner, we first establish a bi-level game-theoretic model that nests a zero-sum game in a moral-hazard type of principal-agent game to capture complex interactions between a user, an attacker, and the insurer. The game framework provides an integrative view of the cyber insurance and enables a systematic design of incentive compatible and attack-aware insurance policy. The framework is further extended to study a network of users and their risk interdependencies. We completely characterize the equilibrium solutions of the bi-level game. Our analytical results provide a fundamental limit on insurability, predict the Peltzman effect, and reveal the principles of zero operating profit and the linear insurance policy of the insurer. We provide analytical results and numerical experiments to corroborate the analytical results and demonstrate the network effects as a result of the strategic interactions among the three types of players.

Attack-Aware Cyber Insurance of Interdependent Computer Networks

Cyber insurance is a valuable approach to mitigate further the cyber risk and its loss in addition to the deployment of technological cyber defense solutions such as intrusion detection systems and firewalls. An effective cyber insurance policy can reduce the number of successful cyber attacks by incentivizing the adoption of preventative measures and the implementation of best practices of the users. To study cyber insurance in a holistic manner, we first establish a bi-level game-theoretic model that nests a zero-sum game in a moral-hazard type of principal-agent game to capture complex interactions between a user, an attacker, and the insurer. The game framework provides an integrative view of the cyber insurance and enables a systematic design of incentive compatible and attack-aware insurance policy. The framework is further extended to study a network of users and their risk interdependencies. We completely characterize the equilibrium solutions of the bi-level game. Our analytical results provide a fundamental limit on insurability, predict the Peltzman effect, and reveal the principles of zero operating profit and the linear insurance policy of the insurer. We provide analytical results and numerical experiments to corroborate the analytical results and demonstrate the network effects as a result of the strategic interactions among three types of players.

Unobservable service quality and moral hazard: the case of impartial business valuations

PurposeThe purpose of this paper is to discuss agency relationships occurring in an impartial business valuation setting. In particular, it shows how monitoring and sanctioning mechanisms, reputational concerns, and competition may affect the quality of valuation services rendered.Design/methodology/approachThe paper reviews findings from auditing research and from the economic theory on credence goods, and applies them to an impartial business valuation setting.FindingsImpartial valuation experts face incentives to either overwork, or underwork and overcharge their client. Which type of moral hazard is more likely to occur depends on the degree of competition among the agents. While market concentration gives rise to overworking, competition promotes underworking and overcharging. Due to regulatory differences, this effect is more pronounced in the valuation services market than in the auditing industry.Research limitations/implicationsThe results imply that a client may be able to infer how to set up an effective monitoring and sanctioning system from the degree of competition among the impartial valuation experts. Future research should empirically validate the theoretical findings, and explore the relationship between service quality and internal governance structures of business valuation firms.Practical implicationsThe results underline the necessity of an effective valuation quality assurance system set up by the client. They are thus relevant for clients, but also for regulatory bodies seeking to ensure the integrity of the valuation services market, and for valuation service providers striving to improve their corporate governance system.Originality/valueThe paper offers a new perspective on the reliability of business values determined by impartial experts. It emphasises the potential influence of the experts' competitive environment on service quality, and it shows how to design an effective valuation quality assurance system.

Using Real-Time Data to Test for Political Budget Cycles

We use real-time annual data on the fiscal balance, government current spending, current revenues and net capital outlays as published at a half yearly frequency in the OECD Economic Outlook for 25 OECD countries. For each fiscal year t we have a number of forecasts, a first release, and subsequent revisions. It turns out that revisions in the fiscal balance data are not affected by elections. However, we do find that governments spend more than reported before an election which provides support for moral-hazard type of political budget cycle (PBC) models: through hidden efforts the incumbent tries to enhance his perceived competence. We also find that governments had higher current receipts than reported before an election, which is in line with adverse-selection type of PBC models in which incumbents signal competence through expansionary fiscal policy before the elections.

Using Real-Time Data to Test for Political Budget Cycles

We use real-time annual data on the fiscal balance, government current spending, current revenues and net capital outlays as published at a half yearly frequency in the OECD Economic Outlook for 25 OECD countries. For each fiscal year t we have a number of forecasts, a first release, and subsequent revisions. It turns out that revisions in the fiscal balance data are not affected by elections. However, we do find that governments spend more than reported before an election which provides support for moralhazard type of political budget cycle (PBC) models: through hidden efforts the incumbent tries to enhance his perceived competence. We also find that governments had higher current receipts than reported before an election, which is in line with adverse-selection type of PBC models in which incumbents signal competence through expansionary fiscal policy before the elections.

Moral hazard among the sick and unemployed: evidence from a Swedish social insurance reform

This paper studies a specific type of moral hazard that arises in the interplay between two large public social insurance systems in Sweden, namely the sickness insurance (SI) and the unemployment insurance (UI). Moral hazard can arise from the structure of the benefit levels as for some unemployed persons benefits from the SI are higher than benefits from the UI. We use a reform of the SI system that came into force on 1 July 2003 to identify the effect of economic incentives arising from the different benefit levels. The purpose of the reform was to eliminate the difference in benefits between the two social insurance systems. Our results from a duration analysis show clearly that the higher the sickness benefits, the higher the probability of reporting sick.

Evergreening in banking

In the dynamic model of banking, a bank's option to hide its loan losses by rolling over non-performing loans is shown to worsen moral hazard. Contrary to the classic theory, moral hazard may arise even when a bank cannot seek a correlated risk for its loans. The loans seem to be performing and the bank makes a profit although it is de facto insolvent. When the bank's balance sheet includes hidden non-performing loans, the bank may optimally shrink lending or gamble for resurrection by growing aggressively. To eliminate this type of moral hazard, which is broadly consistent with evidence from emerging economies, a few regulatory implications are suggested.

Credit Risk Transfer, Delegated Monitoring, Real Sector Productivity, and Financial Deepening

We examine the effect which credit risk transfer (CRT) markets have on real sector productivity and the volume of financial intermediation in an economy. We find that, despite a reduction in per-firm monitoring, CRT increases productivity in the up-market segment of the real sector but decreases at the lower end. Also, we find that CRT, if optimal, unambiguously fosters financial deepening, that is, it leads to more financial intermediation in the sense that otherwise credit-rationed firms receive access to outside funding. These overall positive effects, however, rely upon the ability of banks to overcome a new type of moral hazard, namely to commit to the optimal amount of CRT. This stems from the fact that a time inconsistency problem arises after deposit contracts are written. Finally, our model predicts that CRT origination should be observed less for high moral hazard loans, for countries where banks are more involved in firms' corporate governance, and for small, regional banks specialized in relationship-intensive loans.

Identifying the Role of Moral Hazard in International Financial Markets

Considerable attention has been paid to the possibility that large-scale IMF-led financing packages may have distorted incentives in international financial markets, leading private investors to provide more credit to emerging market countries, and at lower interest rates, than might otherwise have been the case. Yet, prior attempts to identify such distortions have yielded mixed evidence, at best. This paper makes three contributions to our ability to assess the empirical importance of moral hazard in international financial markets. First, it is argued that, because large international ‘bail-outs’ did not commence until the 1995 Mexican crisis, financial indicators prior to that time could not have reflected a significant degree of this type of moral hazard. Therefore, one test for the existence of moral hazard is that the access of emerging markets to international credit is significantly easier than it was prior to 1995. Second, the paper argues that because private investors expect large-scale IMF-led packages to be extended primarily to economically or geo-politically important countries, moral hazard, if it exists, should lead these countries to have easier terms of access to credit than smaller, non-systemically important countries. Finally, in addition to looking at bond spreads, the focus of earlier empirical analyses of moral hazard, the paper also examines trends in capital flows to gauge the access of emerging market countries to external finance. Looking at the evidence in light of these considerations, the paper concludes that there is little support for the view that moral hazard is significantly distorting international capital markets at the present time.

Identifying the Role of Moral Hazard in International Financial Markets

AbstractConsiderable attention has been paid to the possibility that large‐scale IMF‐led financing packages may have distorted incentives in international financial markets, leading private investors to provide more credit to emerging market countries, and at lower interest rates, than might otherwise have been the case. Yet, prior attempts to identify such distortions have yielded mixed evidence, at best. This paper makes three contributions to our ability to assess the empirical importance of moral hazard in international financial markets. First, it is argued that, because large international ‘bail‐outs’ did not commence until the 1995 Mexican crisis, financial indicators prior to that time could not have reflected a significant degree of this type of moral hazard. Therefore, one test for the existence of moral hazard is that the access of emerging markets to international credit is significantly easier than it was prior to 1995. Second, the paper argues that because private investors expect large‐scale IMF‐led packages to be extended primarily to economically or geo‐politically important countries, moral hazard, if it exists, should lead these countries to have easier terms of access to credit than smaller, non‐systemically important countries. Finally, in addition to looking at bond spreads, the focus of earlier empirical analyses of moral hazard, the paper also examines trends in capital flows to gauge the access of emerging market countries to external finance. Looking at the evidence in light of these considerations, the paper concludes that there is little support for the view that moral hazard is significantly distorting international capital markets at the present time.

Identifying the Role of Moral Hazard in International Financial Markets

Considerable attention has been paid to the possibility that large-scale IMF-led financing packages may have distorted incentives in international financial markets, leading private investors to provide more credit to emerging market countries, and at lower interest rates, than might otherwise have been the case. Yet, prior attempts to identify such distortions have yielded mixed evidence, at best. This paper makes three contributions to our ability to assess the empirical importance of moral hazard in international financial markets. First, it is argued that because large international "bailouts" did not commence until the 1995 Mexican crisis, financial indicators prior to that time could not have reflected a significant degree of this type of moral hazard. Therefore, one test for the existence of moral hazard is that the access of emerging markets to international credit is significantly easier than it was prior to 1995. Second, the paper argues that because private investors expect large-scale IMF-led packages to be extended primarily to economically or geo-politically important countries, moral hazard, if it exists, should lead these countries to have easier terms of access to credit than smaller, non-systemically important countries. Finally, in addition to looking at bond spreads, the focus of earlier empirical analyses of moral hazard, the paper also examines trends in capital flows to gauge the access of emerging market countries to external finance. Looking at the evidence in light of these considerations, the paper concludes that there is little support for the view that moral hazard is significantly distorting international capital markets at the present time.