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Estimating Dynamic Contracts: Risk Sharing in Village Economies

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  • Sarolta Laczo

    (European University Institute)

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    Abstract

    This paper studies the role of preference and income risk heterogeneity when risk sharing is partial due to limited commitment. I estimate the dynamic contract determining self-enforcing insurance transfers in a structural manner, and allow the coefficient of relative risk aversion and multiplicative income risk to differ across households. I find that the model explains the consumption allocation significantly better than the homogenous version and the benchmarks of perfect risk sharing and autarky, using household survey data from rural Pakistan. Enforcement constraints bind more often with heterogeneous households, implying less risk sharing. The paper then examines how social policies would interact with existing informal insurance arrangements. I simulate the effects of counterfactual transfers targeting the poor on consumption by both eligible and ineligible households. In the case of a one-time transfer, the heterogeneous (homogeneous) model predicts that consumption by ineligible households increases by one fifth (one fourth) of the transfer; if the transfer is permanent, the predicted share of ineligible households is one tenth (one fifth).

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    Bibliographic Info

    Paper provided by Society for Economic Dynamics in its series 2010 Meeting Papers with number 687.

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    Date of creation: 2010
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    Handle: RePEc:red:sed010:687

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    4. Alderman, Harold & Garcia, Marito, 1993. "Poverty, household food security, and nutrition in rural Pakistan:," Research reports 96, International Food Policy Research Institute (IFPRI).
    5. Ligon, Ethan & Thomas, Jonathan P & Worrall, Tim, 2002. "Informal Insurance Arrangements with Limited Commitment: Theory and Evidence from Village Economies," Review of Economic Studies, Wiley Blackwell, vol. 69(1), pages 209-44, January.
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    19. 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.
    20. Laura Schechter, 2007. "Theft, Gift-Giving, and Trustworthiness: Honesty Is Its Own Reward in Rural Paraguay," American Economic Review, American Economic Association, vol. 97(5), pages 1560-1582, December.
    21. Sam Schulhofer-Wohl, 2007. "Heterogeneity, Risk Sharing and the Welfare Costs of Risk," 2007 Meeting Papers 926, Society for Economic Dynamics.
    22. Laurence Ales & Pricila Maziero, . "Non-exclusive Dynamic Contracts, Competition, and the Limits of Insurance," GSIA Working Papers 2010-E59, Carnegie Mellon University, Tepper School of Business.
    23. Wang, Cheng, 1995. "Dynamic Insurance with Private Information and Balanced Budgets," Review of Economic Studies, Wiley Blackwell, vol. 62(4), pages 577-95, October.
    24. Coate, Stephen & Ravallion, Martin, 1993. "Reciprocity without commitment : Characterization and performance of informal insurance arrangements," Journal of Development Economics, Elsevier, vol. 40(1), pages 1-24, February.
    25. Mace, Barbara J, 1991. "Full Insurance in the Presence of Aggregate Uncertainty," Journal of Political Economy, University of Chicago Press, vol. 99(5), pages 928-56, October.
    26. Kenneth I. Wolpin & Petra E. Todd, 2006. "Assessing the Impact of a School Subsidy Program in Mexico: Using a Social Experiment to Validate a Dynamic Behavioral Model of Child Schooling and Fertility," American Economic Review, American Economic Association, vol. 96(5), pages 1384-1417, December.
    27. 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.
    28. Wang, Cheng, 1995. "Dynamic Insurance with Private Information and Balanced Budgets," Staff General Research Papers 5249, Iowa State University, Department of Economics.
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