Optimal contracts in continuous-time models

Cvitanić, Jakša; Wan, Xuhu; Zhang, Jianfeng

doi:https://doi.org/10.1155/JAMSA/2006/95203

International Journal of Stochastic Analysis

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Volume 2006 | Article ID 095203 | https://doi.org/10.1155/JAMSA/2006/95203

Optimal contracts in continuous-time models

Jakša Cvitanić,¹Xuhu Wan,²and Jianfeng Zhang³

Received17 Nov 2005

Revised03 Feb 2006

Accepted19 Feb 2006

Published12 Jul 2006

Abstract

We present a unified approach to solving contracting problems with full information in models driven by Brownian motion. We apply the stochastic maximum principle to give necessary and sufficient conditions for contracts that implement the so-called first-best solution. The optimal contract is proportional to the difference between the underlying process controlled by the agent and a stochastic, state-contingent benchmark. Our methodology covers a number of frameworks considered in the existing literature. The main finance applications of this theory are optimal compensation of company executives and of portfolio managers.

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Copyright

Copyright © 2006 Jakša Cvitanić et al. This is an open access article distributed under the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.

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