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Optimal Dynamic Risk Sharing when Enforcement is a Decision Variable

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Author Info
Thorsten Koeppl () (Department of Economics, Queen's University)

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Abstract

Societies provide institutions that are costly to set up, but able to enforce long-run relationships. We study the optimal decision problem of using self-governance for risk sharing or governance through enforcement provided by these institutions. Third-party enforcement is modelled as a costly technology that consumes resources, but permits the punishment of agents who deviate from ex-ante specified allocations. We show that it is optimal to employ the technology whenever commitment problems prevent first-best risk sharing, but never optimal to provide incentives exclusively via this technology. Commitment problems then persist and the optimal incentive structure changes dynamically over time with third-party enforcement monotonically increasing in the relative inequality between agents.

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File URL: http://www.econ.queensu.ca/working_papers/papers/qed_wp_1050.pdf
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File Function: First version 2005
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Publisher Info
Paper provided by Queen's University, Department of Economics in its series Working Papers with number 1050.

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Length: 43 pages
Date of creation: Jan 2005
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Publication status: Forthcoming in Journal of Economic Theory
Handle: RePEc:qed:wpaper:1050

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Related research
Keywords: Limited Commitment Risk Sharing Third-party Enforcement

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Find related papers by JEL classification:
C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
D60 - Microeconomics - - Welfare Economics - - - General
D91 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Consumer Choice; Life Cycle Models and Saving
K49 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior - - - Other

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References listed on IDEAS
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. Kocherlakota, Narayana R, 1996. "Implications of Efficient Risk Sharing without Commitment," Review of Economic Studies, Blackwell Publishing, vol. 63(4), pages 595-609, October. [Downloadable!] (restricted)
  2. Garance Genicot & Debraj Ray, 2003. "Group Formation in Risk--Sharing Arrangements," Review of Economic Studies, Blackwell Publishing, vol. 70(1), pages 87-113, January.
  3. Ethan Ligon & Jonathan P. Thomas & Tim Worrall, 2000. "Mutual Insurance, Individual Savings and Limited Commitment," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 3(2), pages 216-246, April. [Downloadable!] (restricted)
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  4. Garey Ramey & Joel Watson, 2002. "Contractual Intermediaries," Journal of Law, Economics and Organization, Oxford University Press, vol. 18(2), pages 362-384, October.
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  5. Spear, Stephen E & Srivastava, Sanjay, 1987. "On Repeated Moral Hazard with Discounting," Review of Economic Studies, Blackwell Publishing, vol. 54(4), pages 599-617, October. [Downloadable!] (restricted)
  6. Kehoe, Timothy J & Levine, David K, 1993. "Debt-Constrained Asset Markets," Review of Economic Studies, Blackwell Publishing, vol. 60(4), pages 865-88, October. [Downloadable!] (restricted)
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  7. Thomas, Jonathan & Worrall, Tim, 1988. "Self-enforcing Wage Contracts," Review of Economic Studies, Blackwell Publishing, vol. 55(4), pages 541-54, October. [Downloadable!] (restricted)
  8. Ligon, Ethan & Thomas, Jonathan P & Worrall, Tim, 2002. "Informal Insurance Arrangements with Limited Commitment: Theory and Evidence from Village Economies," Review of Economic Studies, Blackwell Publishing, vol. 69(1), pages 209-44, January.
  9. Rustichini, Aldo, 1998. "Dynamic Programming Solution of Incentive Constrained Problems," Journal of Economic Theory, Elsevier, vol. 78(2), pages 329-354, February. [Downloadable!] (restricted)
  10. Avinash Dixit, 2003. "On Modes of Economic Governance," Econometrica, Econometric Society, vol. 71(2), pages 449-481, March. [Downloadable!] (restricted)
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  11. Phelan Christopher, 1995. "Repeated Moral Hazard and One-Sided Commitment," Journal of Economic Theory, Elsevier, vol. 66(2), pages 488-506, August. [Downloadable!] (restricted)
  12. Stefan Krasa & Anne P. Villamil, 2000. "Optimal Contracts when Enforcement Is a Decision Variable," Econometrica, Econometric Society, vol. 68(1), pages 119-134, January.
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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. Beth Allen, 2006. "Market games with asymmetric information: the core," Economic Theory, Springer, vol. 29(2), pages 465-487, October. [Downloadable!] (restricted)
  2. Thorsten Koeppl, 2004. "Risk Sharing through Financial Markets with Endogenous Enforcement of Trades," Working Papers 1048, Queen's University, Department of Economics. [Downloadable!]
    Other versions:
  3. Erwan Quintin & Thorsten Koeppl & Cyril Monnet, 2008. "The poor, the rich and the enforcer: institutional choice and growth," Working Papers 0801, Federal Reserve Bank of Dallas. [Downloadable!]
    Other versions:
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