Moral hazard refers to a situation where one party makes riskier decisions because another party will bear the costs if things go badly. [1] It arises due to information asymmetry - the party taking the actions knows more about their risks than the party paying the costs. [2] Common examples include people being less cautious with insured items like cars or health, and borrowers spending loan funds recklessly since the lender bears default risk. [3] Moral hazard can also affect politicians and corporate managers if their interests diverge from constituents or shareholders they are meant to serve.

1. Game Theory
Moral Hazard
Sandeep Gunjan
Ashok Bhardwaj
Khyati Bhola

2. What is moral “Hazard”?
In economic theory, moral hazard refers to a situation in which a
party makes a decision about how much risk to take, while another
party bears the costs if things go badly, and the party insulated from
risk behaves differently from how it would if it were fully exposed to
the risk.
It is the form of
• Post contractual opportunism
• That arises because actions that have efficiency consequences
are not freely observable (monitoring problem)
• So the person taking them may choose to pursue his or her
private interests at others’ expense

3. Moral Hazard Term History
According to research by Dembe and Boden, the term
dates back to the 17th century, and was widely used by
English insurance companies by the late 19th century.
Early usage of the term carried negative connotations,
implying fraud or immoral behaviour (usually on the part
of an insured party).

4. Moral Hazard Game
Player 1
3 1
0
Player 2 0,0 Player 2
-3 3 1
-1
3,3 -1,1 1,1.5
3,2

5. Moral Hazard Example: Insurance
For example, a person with insurance against
automobile theft may be less cautious about locking
his or her car, because the negative consequences of
vehicle theft are (partially) the responsibility of the
insurance company. Below are some more examples
of Moral Hazard:-
• Fire Insurance
• Term Life Insurance (?)
• Health Insurance

6. Moral Hazard Example: Finance
Moral hazard also occur with borrowers. Borrowers may not
act prudently (in the view of the lender) when they invest or
spend funds recklessly.
For example, credit card companies often limit the amount
borrowers can spend with their cards, because without such
limits borrowers may spend borrowed funds recklessly, leading
to default.

7. Moral Hazard Example: Politician
• Elected people has public trust. Which can not be
cannot usually be monitored much of the time.
• They may pursue their personal interests rather than
those of the public.

8. Moral Hazard Example: Management
• Senior Management members may pursue their own goals of
status, high salaries, expensive perks, and job security rather
than the stockholders’ interests
• They may push sales growth over profits.
• They may treat themselves to huge staffs and corporate jets.
• They may oppose takeovers that would oust them and increase
the value of the firm.
• Senior Management members may ignore the shareholder’s
rightful claims, building executive offices that are not exactly
Spartan by nature.

9. Illustration
In the presence of uncertainty:
Assign the risk to the better informed party.
Efficiency and greater profits result.
The more risks are transferred to the well-
informed party, the more profit is earned.
•9

10. Warning
In the presence of uncertainty:
Assign the risk to the better informed party.
Efficiency and greater profits result.
BUT
If done imprecisely,
may be better not to bother.
•10

11. Thank you.