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Risk-Sharing in Village Economies Revisited

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  • Broer, Tobias
  • Bold, Tessa

Abstract

The limited commitment model is popular for the analysis of village risk-sharing as it captures both the observed partial character of insurance and the presumption that incomes are well observed but formal contracts absent in rural communities. We study dynamic limited commitment when individuals can form new, smaller coalitions after reneging in a larger group, which makes group size an endogenous outcome of the model. This is important for theoretical consistency, but also because we show that enforcement constraints, which typically bind only in case of positive income shocks, counterfactually imply a stronger response of consumption to income increases than to income losses in village-size insurance groups. In small groups, in contrast, the response of consumption to income increases and declines is symmetric. The results show how equilibrium group sizes are much smaller than the typical village, bringing the predicted consumption process in line with the data. We thus argue that allowing for endogenous group formation in the dynamic limited commitment model strongly improves its predictive power for analyzing risk-sharing in village economies.

Suggested Citation

  • Broer, Tobias & Bold, Tessa, 2016. "Risk-Sharing in Village Economies Revisited," CEPR Discussion Papers 11143, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:11143
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    2. Foss, Sergey & Shneer, Vsevolod & Thomas, Jonathan P. & Worrall, Tim, 2018. "Stochastic stability of monotone economies in regenerative environments," Journal of Economic Theory, Elsevier, vol. 173(C), pages 334-360.

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    More about this item

    Keywords

    Risk-sharing; Village economies; Informal insurance; Dynamic limited commitment; Renegotiation-proofness;
    All these keywords.

    JEL classification:

    • D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
    • D12 - Microeconomics - - Household Behavior - - - Consumer Economics: Empirical Analysis
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets

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