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Informal Risk Sharing in an Infinite-horizon Experiment

  • Charness, Gary B
  • Genicot, Garance

This paper presents the first laboratory study of risk-sharing without commitment. Our experiment captures the main features of a simple model of voluntary insurance between two agents. In the model, two individuals interact over a potential infinite horizon and suffer random income shocks. Risk-averse individuals have incentives to smooth consumption by making transfers to each other. These transfers being voluntary, only self-enforcing risk-sharing arrangements are possible: transfers can never be so large as to tempt individuals to renege on them. This constraint, when binding, has strong implications for the shape of the constrained optimal risk-sharing arrangement. In our experiment, participants are matched in pairs. Each period, one of them, randomly drawn, receives a given amount in addition to its regular income. After observing both incomes, each person in a pair chooses a non-negative transfer to make to the other person. Two features of the experimental design are crucial. First, it is common information that all pairs will be dissolved at the end of each period with a given probability. Participants are informed when this occurs and randomly re-matched. This replicates the effect of infinite-horizon and discounting in the model. Second, at the end of the experiment, a single period is randomly drawn to count for cash payment. This feature is essential for individuals to care about the utility outcome of each period. We find evidence generally consistent with risk sharing, with most transfers coming from individuals who received h in the period. Moreover, in support of the theory, transfers are much higher with a higher continuation probability and they also are highly correlated with the individual’s degree of risk aversion. However, while the model predicts an increase in transfers with ex ante inequality, we observe the opposite effect. This may reflect considerations of identity or group membership.

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Paper provided by Department of Economics, UC Santa Barbara in its series University of California at Santa Barbara, Economics Working Paper Series with number qt9sn8t91g.

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Date of creation: 01 Feb 2008
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Handle: RePEc:cdl:ucsbec:qt9sn8t91g
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  1. Kocherlakota, Narayana R, 1996. "Implications of Efficient Risk Sharing without Commitment," Review of Economic Studies, Wiley Blackwell, vol. 63(4), pages 595-609, October.
  2. Stefan Dercon & Pramila Krishnan, 1997. "In sickness and in health... risk-sharing within households in rural Ethiopia," Economics Series Working Papers WPS/1997-12, University of Oxford, Department of Economics.
  3. Kimball, Miles S, 1988. "Farmers' Cooperatives as Behavior Toward Risk," American Economic Review, American Economic Association, vol. 78(1), pages 224-32, March.
  4. Brian D. Wright & Kenneth M. Kletzer, 2000. "Sovereign Debt as Intertemporal Barter," American Economic Review, American Economic Association, vol. 90(3), pages 621-639, June.
  5. John Bone & John Hey & John Suckling, . "A Simple Risk-Sharing Experiment," Discussion Papers 00/36, Department of Economics, University of York.
  6. Paul Gertler & Jonathan Gruber, 2002. "Insuring Consumption Against Illness," American Economic Review, American Economic Association, vol. 92(1), pages 51-70, March.
  7. John Duffy & Jack Ochs, 2006. "Cooperative Behavior and the Frequency of Social Interaction," Working Papers 274, University of Pittsburgh, Department of Economics, revised Jul 2008.
  8. Camerer, Colin F & Ho, Teck-Hua, 1994. "Violations of the Betweenness Axiom and Nonlinearity in Probability," Journal of Risk and Uncertainty, Springer, vol. 8(2), pages 167-96, March.
  9. Charness, Gary & Rabin, Matthew, 2002. "Understanding Social Preferences with Simple Tests," Department of Economics, Working Paper Series qt3d04q5sm, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  10. Ethan Ligon & Jonathan P. Thomas & Tim Worrall, 2002. "Informal Insurance Arrangements with Limited Commitment: Theory and Evidence from Village Economies," Review of Economic Studies, Oxford University Press, vol. 69(1), pages 209-244.
  11. Selten, Reinhard & Ockenfels, Axel, 1998. "An experimental solidarity game," Journal of Economic Behavior & Organization, Elsevier, vol. 34(4), pages 517-539, March.
  12. Dubois, Pierre & Ligon, Ethan A., 2011. "Incentives and nutrition for rotten kids: intrahousehold food allocation in the Philippines," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series qt0c6758hs, Department of Agricultural & Resource Economics, UC Berkeley.
  13. Jalan, Jyotsna & Ravallion, Martin, 1997. "Are the poor less well-insured? Evidence on vulnerability to income risk in rural China," Policy Research Working Paper Series 1863, The World Bank.
  14. repec:ner:tilbur:urn:nbn:nl:ui:12-73908 is not listed on IDEAS
  15. Townsend, R.M., 1991. "Risk and Insurance in Village India," University of Chicago - Economics Research Center 91-3, Chicago - Economics Research Center.
  16. 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.
  17. Reinhard Selten & Abdolkarim Sadrieh & Klaus Abbink, 1999. "Money Does Not Induce Risk Neutral Behavior, but Binary Lotteries Do even Worse," Theory and Decision, Springer, vol. 46(3), pages 213-252, June.
  18. Gneezy, U. & Potters, J.J.M., 1996. "An experiment on risk taking and evaluation periods," Discussion Paper 1996-61, Tilburg University, Center for Economic Research.
  19. Masaki Aoyagi & Guillaume R. Frechette, 2004. "Collusion in Repeated Games with Imperfect Public Monitoring," Levine's Bibliography 122247000000000127, UCLA Department of Economics.
  20. Cason, Timothy N., 1995. "Cheap talk price signaling in laboratory markets," Information Economics and Policy, Elsevier, vol. 7(2), pages 183-204, June.
  21. George A. Akerlof & Rachel E. Kranton, 2000. "Economics And Identity," The Quarterly Journal of Economics, MIT Press, vol. 115(3), pages 715-753, August.
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