Endogenous Insurance and Informal Relationships
AbstractA rich literature seeks to explain the distinctive features of equilibrium institutions arising in risky environments which lack formal insurance and credit markets. I develop a theory of endogenous matching between heterogeneously risk-averse individuals who, once matched, choose both the riskiness of the income stream they face (ex ante risk management) as well as how to share that risk (ex post risk management). I find a clean condition on the fundamentals of the model for unique positive-assortative and negative-assortative matching in risk attitudes. From this, I derive an intuitive falsifiability condition, discuss support for the theory in existing empirical work, and propose an experimental design to test the theory. Finally, I demonstrate the policy importance of understanding informal insurance as the risk-sharing achieved within the equilibrium network of partnerships, rather than within a single, isolated partnership. A hypothetical policy which reduces aggregate risk is a strict Pareto improvement if the matching is unchanged, but can be seen to harm the most risk-averse individuals and to exacerbate inequality when the endogenous network response is taken into account: the least risk-averse individuals abandon their roles as informal insurers in favor of entrepreneurial partnerships. This results in an increase in the risk borne by the most risk-averse agents, who must now match with each other on low-return investments.
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Bibliographic InfoPaper provided by Duke University, Department of Economics in its series Working Papers with number 13-24.
Date of creation: 2013
Date of revision:
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assortative matching; risk sharing; informal insurance; formal insurance; group formation;
Find related papers by JEL classification:
- O1 - Economic Development, Technological Change, and Growth - - Economic Development
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- O16 - Economic Development, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance
- O17 - Economic Development, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements
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