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Endogenous Insurance and Informal Relationships

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  • Xiao Yu Wang

Abstract

A rich literature seeks to explain the distinctive features of equilibrium institutions arising in risky environments which lack formal insurance and credit markets. I develop a theory of endogenous matching between heterogeneously risk-averse individuals who, once matched, choose both the riskiness of the income stream they face (ex ante risk management) as well as how to share that risk (ex post risk management). I find a clean condition on the fundamentals of the model for unique positive-assortative and negative-assortative matching in risk attitudes. From this, I derive an intuitive falsifiability condition, discuss support for the theory in existing empirical work, and propose an experimental design to test the theory. Finally, I demonstrate the policy importance of understanding informal insurance as the risk-sharing achieved within the equilibrium network of partnerships, rather than within a single, isolated partnership. A hypothetical policy which reduces aggregate risk is a strict Pareto improvement if the matching is unchanged, but can be seen to harm the most risk-averse individuals and to exacerbate inequality when the endogenous network response is taken into account: the least risk-averse individuals abandon their roles as informal insurers in favor of entrepreneurial partnerships. This results in an increase in the risk borne by the most risk-averse agents, who must now match with each other on low-return investments.

Suggested Citation

  • Xiao Yu Wang, 2013. "Endogenous Insurance and Informal Relationships," Working Papers 13-24, Duke University, Department of Economics.
  • Handle: RePEc:duk:dukeec:13-24
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    Cited by:

    1. Chiappori, Pierre-André & Reny, Philip J., 2016. "Matching to share risk," Theoretical Economics, Econometric Society, vol. 11(1), January.
    2. Li, Sanxi & Sun, Hailin & Wang, Tong & Yu, Jun, 2016. "Assortative matching and risk sharing," Journal of Economic Theory, Elsevier, vol. 163(C), pages 248-275.

    More about this item

    Keywords

    assortative matching; risk sharing; informal insurance; formal insurance; group formation;

    JEL classification:

    • O1 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development
    • O13 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Agriculture; Natural Resources; Environment; Other Primary Products
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance
    • O17 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Formal and Informal Sectors; Shadow Economy; Institutional Arrangements

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