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Implications of Endogenous Group Formation for Efficient Risk-Sharing

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  • Tessa Bold

Abstract

This paper models the implications of endogenous group formation for efficient risk-sharing contracts in the dynamic limited commitment model. Endogenising group formation requires that any risk-sharing arrangement is not only stable with respect to individual deviations but also with respect to deviations by sub-groups. This requirement alters the central predictions of the dynamic limited commitment model for efficient bilateral risk-sharing. Firstly, consumption of constrained agents depends on the previous history of shocks and the interaction of the history of shocks with the current income realizations of other constrained agents. As a consequence, the efficient contract does not display amnesia. Secondly, the covariance between current consumption and past income can take on negative values. Based on the first result, we derive a formal test for the presence of endogenous group formation under limited commitment. In addition, we show how this test can be extended to distinguish a limited commitment/perfect information environment from a full commitment/imperfect information environment empirically.

Suggested Citation

  • Tessa Bold, 2008. "Implications of Endogenous Group Formation for Efficient Risk-Sharing," Economics Series Working Papers 387, University of Oxford, Department of Economics.
  • Handle: RePEc:oxf:wpaper:387
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    File URL: http://www.economics.ox.ac.uk/materials/working_papers/paper387.pdf
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    References listed on IDEAS

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    1. De Weerdt, Joachim & Dercon, Stefan, 2006. "Risk-sharing networks and insurance against illness," Journal of Development Economics, Elsevier, vol. 81(2), pages 337-356, December.
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    3. Dubois, P., 2005. "Heterogeneity of preferences, limited commitment and coalitions : empirical evidence on the limits to risk sharing in rural Pakistan," Economics Working Paper Archive (Toulouse) 200505, French Institute for Agronomy Research (INRA), Economics Laboratory in Toulouse (ESR Toulouse).
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    5. Albert Marcet & Ramon Marimon, 1994. "Recursive contracts," Economics Working Papers 337, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 1998.
    6. Farrell, Joseph & Maskin, Eric, 1989. "Renegotiation in repeated games," Games and Economic Behavior, Elsevier, vol. 1(4), pages 327-360, December.
    7. Garance Genicot & Debraj Ray, 2003. "Group Formation in Risk-Sharing Arrangements," Review of Economic Studies, Oxford University Press, vol. 70(1), pages 87-113.
    8. Maurizio Mazzocco, 2007. "Household Intertemporal Behaviour: A Collective Characterization and a Test of Commitment," Review of Economic Studies, Oxford University Press, vol. 74(3), pages 857-895.
    9. Koeppl Thorsten V., 2006. "Differentiability of the Efficient Frontier when Commitment to Risk Sharing is Limited," The B.E. Journal of Macroeconomics, De Gruyter, vol. 6(1), pages 1-6, April.
    10. Murgai, Rinku & Winters, Paul & Sadoulet, Elisabeth & Janvry, Alain de, 2002. "Localized and incomplete mutual insurance," Journal of Development Economics, Elsevier, vol. 67(2), pages 245-274, April.
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    12. Narayana R. Kocherlakota, 1996. "Implications of Efficient Risk Sharing without Commitment," Review of Economic Studies, Oxford University Press, vol. 63(4), pages 595-609.
    13. Judd, Kenneth L., 1992. "Projection methods for solving aggregate growth models," Journal of Economic Theory, Elsevier, vol. 58(2), pages 410-452, December.
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    More about this item

    Keywords

    Risk-Sharing; Limited Commitment; Endogenous Group Formation;

    JEL classification:

    • D02 - Microeconomics - - General - - - Institutions: Design, Formation, Operations, and Impact
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games

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