Principal-agent problems with adverse selection: A stochastic target problem formulation
Theoretical Economics
2026-05-19 v2 Optimization and Control
Abstract
We study a principal-agent problem with adverse selection, where the principal does not know the agent's true cost but must design a contract to optimize a specific criterion. Unlike standard screening frameworks that allow for self-selection, we assume the principal can only offer a unique contract. We show that the agent's optimization problem can be reformulated as a stochastic target problem. After characterizing the credible domain of this target problem, we show that the principal's objective can be solved as a stochastic optimal control problem with partial information and state constraints. The description of the credible domain also allows us to obtain the value of screening contracts.
Keywords
Cite
@article{arxiv.2605.01080,
title = {Principal-agent problems with adverse selection: A stochastic target problem formulation},
author = {Guillermo Alonso Alvarez and Ibrahim Ekren and Liwei Huang},
journal= {arXiv preprint arXiv:2605.01080},
year = {2026}
}