Moral hazard is a situation where
A)a self-interested agent has an attribute that is unknown to the principal prior to contracting
B)the principal undertakes an action at the expense of the agent
C)a self-interested agent undertakes an unobservable action at the expense of the principal and the outcome of that action contains some noise
D)both a and b
E)both b and c

Question

Quizplus · Accepted Answer

Moral hazard occurs when a party insulated from risk behaves differently than it would behave if it were fully exposed to the risk. It specifically involves a situation where a self-interested agent (such as an employee or a borrower) takes an action that is not observable by the principal (such as an employer or a lender), and this action is at the expense of the principal. The outcome of the action contains some level of uncertainty or "noise," making it difficult for the principal to ascertain the true nature of the agent's actions.

Moral Hazard Is a Situation Where