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Implications of Endogenous Group Formation for Efficient Risk-Sharing

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  • Tessa Bold
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    Abstract

    This paper models the implications of endogenous group formation for efficient risk-sharing contracts in the dynamic limited commitment model.� Endogenising group formation requires that any risk-sharing arrangement is not only stable with respect to individual deviations but also with respect to deviations by sub-groups.� This requirement alters the central predictions of the dynamic limited commitment model for efficient bilateral risk-sharing.� Firstly, consumption of constrained agents depends on the previous history of shocks and the interaction of the history of shocks with the current income realizations of other constrained agents.� As a consequence, the efficient contract does not display amnesia.� Secondly, the covariance between current consumption and past income can take on negative values.� Based on the first result, we derive a formal test for the presence of endogenous group formation under limited commitment.� In addition, we show how this test can be extended to distinguish a limited commitment/perfect information environment from a full commitment/imperfect information environment empirically.

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    Bibliographic Info

    Paper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number 387.

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    Date of creation: 01 Feb 2008
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    Handle: RePEc:oxf:wpaper:387

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    Keywords: Risk-Sharing; Limited Commitment; Endogenous Group Formation;

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    1. Albert Marcet & Ramon Marimon, 2011. "Recursive Contracts," Working Papers 552, Barcelona Graduate School of Economics.
    2. Thorsten Koeppl, 2004. "Differentiability of the Efficient Frontier when Commitment to Risk Sharing is Limited," Working Papers 1049, Queen's University, Department of Economics.
    3. Kocherlakota, Narayana R, 1996. "Implications of Efficient Risk Sharing without Commitment," Review of Economic Studies, Wiley Blackwell, vol. 63(4), pages 595-609, October.
    4. Attanasio, Orazio & Rios-Rull, Jose-Victor, 2000. "Consumption smoothing in island economies: Can public insurance reduce welfare?," European Economic Review, Elsevier, vol. 44(7), pages 1225-1258, June.
    5. Ethan Ligon & Jonathan P. Thomas & Tim Worrall, 2002. "Informal Insurance Arrangements with Limited Commitment: Theory and Evidence from Village Economies," Review of Economic Studies, Oxford University Press, vol. 69(1), pages 209-244.
    6. Joseph Farrell and Eric Maskin., 1987. "Renegotiation in Repeated Games," Economics Working Papers 8759, University of California at Berkeley.
    7. Garance Genicot & Debraj Ray, 2003. "Group Formation in Risk--Sharing Arrangements," Review of Economic Studies, Wiley Blackwell, vol. 70(1), pages 87-113, January.
    8. De Weerdt, Joachim & Dercon, Stefan, 2006. "Risk-sharing networks and insurance against illness," Journal of Development Economics, Elsevier, vol. 81(2), pages 337-356, December.
    9. Murgai, Rinku & Winters, Paul & Sadoulet, Elisabeth & Janvry, Alain de, 2002. "Localized and incomplete mutual insurance," Journal of Development Economics, Elsevier, vol. 67(2), pages 245-274, April.
    10. Dubois, Pierre, 2005. "Heterogeneity of Preferences, Limited Commitment and Coalitions Empirical Evidence on the Limits to Risk Sharing in Rural Pakistan," IDEI Working Papers 391, Institut d'Économie Industrielle (IDEI), Toulouse.
    11. Judd, Kenneth L., 1992. "Projection methods for solving aggregate growth models," Journal of Economic Theory, Elsevier, vol. 58(2), pages 410-452, December.
    12. Maurizio Mazzocco, 2007. "Household Intertemporal Behaviour: A Collective Characterization and a Test of Commitment," Review of Economic Studies, Oxford University Press, vol. 74(3), pages 857-895.
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