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Implications of Endogenous Group Formation for Efficient Risk‐Sharing

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  • Tessa Bold

Abstract

The existing literature on sub‐game perfect risk‐sharing suffers from a basic inconsistency. While a group of size n is able to coordinate on a risk‐sharing outcome, it is assumed that deviating subgroups cannot. I relax this assumption and characterise the optimal contract among all coalition‐proof history‐dependent contracts. This alters the predictions of the standard dynamic limited commitment model. I show that the consumption of constrained agents depends on both the history of shocks and its interaction with the current income of other constrained agents. From this, I derive a formal test for the presence of endogenous group formation under limited commitment.

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  • Tessa Bold, 2009. "Implications of Endogenous Group Formation for Efficient Risk‐Sharing," Economic Journal, Royal Economic Society, vol. 119(536), pages 562-591, March.
  • Handle: RePEc:wly:econjl:v:119:y:2009:i:536:p:562-591
    DOI: 10.1111/j.1468-0297.2008.02245.x
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