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Sharing Risk Efficiently under Suboptimal Punishments for Defection

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  • Drew Saunders

Abstract

The paper studies efficient risk sharing under limited enforcement (or "limited commitment") constraints determined by the threat of punishment after misbehavior. As in Kocherlakota (1996), I assume that society chooses from among those allocations implementable in subgame perfect equilibrium. Rather than assume that punishments implement the least desirable continuation equilibrium, I allow that punishments may be suboptimally specified from the point of view of enforcement. I characterize (up to a technical condition) the set of allocations that may be interpreted as efficient subject to enforcement by some punishment. The conditions rationalizing such efficiency are very weak; they are (i) resource exhaustion, (ii) satisfaction of individual rationality constraints at each continuation, and (iii) fniteness of the value of the allocation under the implicit decentralizing price system, the "high implied interest rates" condition of Alvarez and Jermann (2000). I show that efficient allocations may be decentralized and I state versions of the Welfare Theorems for my environment.

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Bibliographic Info

Paper provided by Purdue University, Department of Economics in its series Purdue University Economics Working Papers with number 1203.

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Length: 38 pages
Date of creation: Aug 2007
Date of revision:
Handle: RePEc:pur:prukra:1203

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  1. Robert M. Townsend, . "Risk and Insurance in Village India," University of Chicago - Population Research Center 91-3a, Chicago - Population Research Center.
  2. Hanno Lustig, 2001. "The Market Price of Aggregate Risk and the Wealth Distribution," Finance 0111004, EconWPA, revised 16 Nov 2001.
  3. 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.
  4. Kehoe, Patrick J. & Perri, Fabrizio, 2004. "Competitive equilibria with limited enforcement," Journal of Economic Theory, Elsevier, vol. 119(1), pages 184-206, November.
  5. Evans, Robert & Maskin, Eric, 1989. "Efficient renegotiation--proof equilibria in repeated games," Games and Economic Behavior, Elsevier, vol. 1(4), pages 361-369, December.
  6. Karsten Jeske, 2006. "Private International Debt with Risk of Repudiation," Journal of Political Economy, University of Chicago Press, vol. 114(3), pages 576-593, June.
  7. Nelson, J.A., 1993. "On Testing for Full Insurance Using Consumer Expenditures Survey Data," Papers 93-02, California Davis - Institute of Governmental Affairs.
  8. Fernández-Villaverde, Jesús & Krueger, Dirk, 2011. "Consumption And Saving Over The Life Cycle: How Important Are Consumer Durables?," Macroeconomic Dynamics, Cambridge University Press, vol. 15(05), pages 725-770, November.
  9. Altug, Sumru & Miller, Robert A, 1990. "Household Choices in Equilibrium," Econometrica, Econometric Society, vol. 58(3), pages 543-70, May.
  10. Hayashi, Fumio & Altonji, Joseph & Kotlikoff, Laurence, 1996. "Risk-Sharing between and within Families," Econometrica, Econometric Society, vol. 64(2), pages 261-94, March.
  11. Patrick J. Kehoe & Fabrizio Perri, 2000. "International business cycles with endogenous incomplete markets," Staff Report 265, Federal Reserve Bank of Minneapolis.
  12. Timothy J Kehoe & David K Levine, 1993. "Debt Constrained Asset Markets," Levine's Working Paper Archive 1276, David K. Levine.
  13. Fernando Alvarez & Urban J. Jermann, 2000. "Efficiency, Equilibrium, and Asset Pricing with Risk of Default," Econometrica, Econometric Society, vol. 68(4), pages 775-798, July.
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