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Formal and Informal Risk Sharing in LDCs: Theory and Empirical Evidence

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Author Info
Dubois, Pierre
Jullien, Bruno
Magnac, Thierry

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Abstract

We develop and estimate a model of dynamic interactions in which commitment is limited and contracts are incomplete to explain the patterns of income and consumption growth in village economies of less developed countries. Households can insure each other through both formal contracts and informal agreements, that is, self-enforcing agreements specifying voluntary transfers. This theoretical setting nests the case of complete markets and the case where only informal agreements are available. We derive a system of non-linear equations for income and consumption growth. A key prediction of our model is that both variables are affected by lagged consumption as a consequence of the interplay of formal and informal contracting possibilities. In a semi-parametric setting, we prove identification, derive testable restrictions and estimate the model with the use of data from Pakistan villages. Empirical results are consistent with the economic arguments. Incentive constraints due to self-enforcement bind with positive probability and formal contracts are used to reduce this probability.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6661.

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Date of creation: Jan 2008
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Handle: RePEc:cpr:ceprdp:6661

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Related research
Keywords: Contracts Incomplete Markets Informal Transfers Risk sharing

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Find related papers by JEL classification:
C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Semiparametric and Nonparametric Methods
D13 - Microeconomics - - Household Behavior - - - Household Production and Intrahouse Allocation
D91 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Consumer Choice; Life Cycle Models and Saving
L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation
O12 - Economic Development, Technological Change, and Growth - - Economic Development - - - Microeconomic Analyses of Economic Development

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  13. Fafchamps, Marcel, 1992. "Solidarity Networks in Preindustrial Societies: Rational Peasants with a Moral Economy," Economic Development and Cultural Change, University of Chicago Press, vol. 41(1), pages 147-74, October.
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Jonathan P Thomas & Tim Worrall, 2007. "Limited Commitment Models of the Labour Market," Keele Economics Research Papers KERP 2007/11, Centre for Economic Research, Keele University. [Downloadable!]
    Other versions:
  2. Notten, Geranda & Neubourg, Chris de, 2007. "Managing risks: what Russian households do to smooth consumption?," MPRA Paper 4670, University Library of Munich, Germany. [Downloadable!]
  3. Pierre Dubois & Bruno Jullien & Thierry Magnac, 2007. "Formal and Informal Risk Sharing in LDCs: Theory and Empirical Evidence," IZA Discussion Papers 2842, Institute for the Study of Labor (IZA). [Downloadable!]
    Other versions:
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