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Self-insurance vs. self-financing: A welfare analysis of the persistence of shocks

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  • Buera, Francisco J.
  • Shin, Yongseok

Abstract

We study the welfare cost of market incompleteness in a generalized Bewley model where idiosyncratic risk takes the form of entrepreneurial productivity shocks. Market incompleteness in our framework has two dimensions. First, in the Bewley tradition, only a limited set of instruments for consumption smoothing is available. Second, entrepreneurs[modifier letter apostrophe] capital rental is subject to collateral constraints. As is well known, it is harder to self-insure against more persistent shocks, and the welfare cost of missing consumption insurance increases with shock persistence. On the other hand, with collateral constraints, an increase in shock persistence leads to better allocation of production factors through entrepreneurs[modifier letter apostrophe] self-financing, and the welfare cost of imperfect capital rental markets decreases with shock persistence. The overall welfare cost of market incompleteness can be increasing, decreasing, or even non-monotone in shock persistence, depending on the relative strengths of its two components--the cost of missing insurance and the cost of imperfect capital markets.

Suggested Citation

  • Buera, Francisco J. & Shin, Yongseok, 2011. "Self-insurance vs. self-financing: A welfare analysis of the persistence of shocks," Journal of Economic Theory, Elsevier, vol. 146(3), pages 845-862, May.
  • Handle: RePEc:eee:jetheo:v:146:y:2011:i:3:p:845-862
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    Cited by:

    1. Hubert Janicki & Henry Hyatt & Emin Dinlersoz, 2015. "Who Works for Whom? Worker Sorting in a Model of Entrepreneurship with Heterogeneous Labor Markets," 2015 Meeting Papers 104, Society for Economic Dynamics.
    2. Ranasinghe, Ashantha, 2017. "Property rights, extortion and the misallocation of talent," European Economic Review, Elsevier, vol. 98(C), pages 86-110.
    3. Maik Heinemann & Alexander Wulff, 2015. "Idiosyncratic Risk, Borrowing Constraints and Financial Integration - A Discussion of Ambiguous Results," Working Papers 2015019, Berlin Doctoral Program in Economics and Management Science (BDPEMS).
    4. Dean Karlan & Robert Osei & Isaac Osei-Akoto & Christopher Udry, 2014. "Agricultural Decisions after Relaxing Credit and Risk Constraints," The Quarterly Journal of Economics, Oxford University Press, vol. 129(2), pages 597-652.
    5. Ashantha Ranasinghe & Diego Restuccia, 2016. "Financial Frictions and the Rule of Law," Working Papers tecipa-554, University of Toronto, Department of Economics.
    6. repec:cen:wpaper:15-08 is not listed on IDEAS
    7. Modalsli, Jørgen Heibø, 2011. "Polarization, Risk and Welfare in General Equilibrium," Memorandum 27/2011, Oslo University, Department of Economics.
    8. William B. Hawkins & Jose Mustre-del-Rio, 2012. "Financial frictions and occupational mobility," Research Working Paper RWP 12-06, Federal Reserve Bank of Kansas City.
    9. Corbae, Dean & Marimon, Ramon, 2011. "Introduction to Incompleteness and Uncertainty in Economics," Journal of Economic Theory, Elsevier, vol. 146(3), pages 775-784, May.
    10. Dmitriy Sergeyev & Neil Mehrotra, 2015. "Financial Shocks and Job Flows," 2015 Meeting Papers 520, Society for Economic Dynamics.
    11. Nicolas Roys, 2016. "Persistence of Shocks and the Reallocation of Labor," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 22, pages 109-130, October.
    12. Allub, Lian & Erosa, Andrés, 2012. "Financial Frictions, Occupational Choice and Economic Inequality," Research Department working papers 1024, CAF Development Bank Of Latinamerica.
    13. Dan Cao & Wenlan Luo, 2017. "Persistent Heterogeneous Returns and Top End Wealth Inequality," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 26, pages 301-326, October.
    14. David Cuberes & Marc Teignier, 2012. "Gender Gaps in the Labor Market and Aggregate Productivity," Working Papers 2012017, The University of Sheffield, Department of Economics.
    15. Galina Vereshchagina, 2014. "Serial Entrepreneurship and the Impact of Credit Constraints of Economic Development," 2014 Meeting Papers 1173, Society for Economic Dynamics.
    16. Wang, Chong & Wang, Neng & Yang, Jinqiang, 2016. "Optimal consumption and savings with stochastic income and recursive utility," Journal of Economic Theory, Elsevier, vol. 165(C), pages 292-331.
    17. Benjamin Moll & Robert M. Townsend & Victor Zhorin, 2013. "Economic Development, Flow of Funds and the Equilibrium Interaction of Financial Frictions," NBER Working Papers 19618, National Bureau of Economic Research, Inc.
    18. Wulff, Alexander & Heinemann, Maik, 2015. "Idiosyncratic Risk, Borrowing Constraints and Financial Integration - A Discussion of Ambiguous Results," Annual Conference 2015 (Muenster): Economic Development - Theory and Policy 113165, Verein für Socialpolitik / German Economic Association.
    19. repec:eee:deveco:v:130:y:2018:i:c:p:203-223 is not listed on IDEAS
    20. David Chivers & Zhigang Feng & Anne Villamil, 2017. "Employment-based Health Insurance and Misallocation: Implications for the Macroeconomy," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 23, pages 125-149, January.

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