Moral Hazard

Moral hazard is the risk one party has when dependent on the virtuous, or moral, behavior of others. These risks increase when there is no effective way to control that behavior. To distinguish moral hazard from all cases in which people misbehave, moral hazard problems arise in situations in which two or more parties form an agreement or contractual relationship, and the arrangement itself creates the incentives for misbehavior. For example, for a person to have an incentive to exceed the posted speed limit so that he or she can be home in time to watch a favorite television show would not be an example of moral hazard. However, if one's employer agrees to pay all misdemeanor moving violations that he or she would incur ...