Testing Efficient Risk Sharing with Heterogeneous Risk Preferences
AbstractPrevious papers have tested efficient risk sharing under the assumption of identical risk preferences. In this paper we show that, if in the data households have heterogeneous risk preferences, the tests proposed in the past reject efficiency even if households share risk efficiently. To address this issue we propose a method that enables one to test efficiency even when households have different preferences for risk. The method is composed of three tests. The first one can be used to determine whether in the data under investigation households have homogeneous risk preferences. The second and third test can be used to evaluate efficient risk sharing when the hypothesis of homogeneous risk preferences is rejected. We use this method to test efficient risk sharing in rural India. Using the first test, we strongly reject the hypothesis of identical risk preferences. We then test efficiency with and without the assumption of preference homogeneity. In the first case we reject efficient risk sharing at the village and caste level. In the second case we still reject efficiency at the village level, but we cannot reject this hypothesis at the caste level. This finding suggests that the relevant risk-sharing unit in rural India is the caste and not the village.
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Bibliographic InfoPaper provided by Society for Economic Dynamics in its series 2010 Meeting Papers with number 237.
Date of creation: 2010
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Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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