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Sharing Risk Efficiently under Suboptimal Punishments for Defection

  • Drew Saunders

The paper studies efficient risk sharing under limited enforcement (or "limited commitment") constraints determined by the threat of punishment after misbehavior. As in Kocherlakota (1996), I assume that society chooses from among those allocations implementable in subgame perfect equilibrium. Rather than assume that punishments implement the least desirable continuation equilibrium, I allow that punishments may be suboptimally specified from the point of view of enforcement. I characterize (up to a technical condition) the set of allocations that may be interpreted as efficient subject to enforcement by some punishment. The conditions rationalizing such efficiency are very weak; they are (i) resource exhaustion, (ii) satisfaction of individual rationality constraints at each continuation, and (iii) fniteness of the value of the allocation under the implicit decentralizing price system, the "high implied interest rates" condition of Alvarez and Jermann (2000). I show that efficient allocations may be decentralized and I state versions of the Welfare Theorems for my environment.

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Paper provided by Purdue University, Department of Economics in its series Purdue University Economics Working Papers with number 1203.

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Length: 38 pages
Date of creation: Aug 2007
Date of revision:
Handle: RePEc:pur:prukra:1203
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  1. Fernando Alvarez & Urban J. Jermann, 2000. "Efficiency, Equilibrium, and Asset Pricing with Risk of Default," Econometrica, Econometric Society, vol. 68(4), pages 775-798, July.
  2. Hanno Lustig, 2001. "The Market Price of Aggregate Risk and the Wealth Distribution," Finance 0111004, EconWPA, revised 16 Nov 2001.
  3. Jesus Fernandez-Villaverde & Dirk Krueger, 2004. "Consumption and Saving over the Life Cycle: How Important are Consumer Durables?," 2004 Meeting Papers 357b, Society for Economic Dynamics.
  4. Sumru Altug & Robert Miller, . "Household Choices in Equilibrium," University of Chicago - Population Research Center 87-8, Chicago - Population Research Center.
  5. Kehoe, Timothy J & Levine, David K, 1993. "Debt-Constrained Asset Markets," Review of Economic Studies, Wiley Blackwell, vol. 60(4), pages 865-88, October.
  6. 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.
  7. Patrick J. Kehoe & Fabrizio Perri, 2000. "International Business Cycles with Endogenous Incomplete Markets," NBER Working Papers 7870, National Bureau of Economic Research, Inc.
  8. Narayana Kocherlakota, 2010. "Implications of Efficient Risk Sharing Without Commitment," Levine's Working Paper Archive 2053, David K. Levine.
  9. Patrick J. Kehoe & Fabrizio Perri, 2002. "Competitive Equilibria With Limited Enforcement," NBER Working Papers 9077, National Bureau of Economic Research, Inc.
  10. Evans, Robert & Maskin, Eric, 1989. "Efficient renegotiation--proof equilibria in repeated games," Games and Economic Behavior, Elsevier, vol. 1(4), pages 361-369, December.
  11. Robert M. Townsend, . "Risk and Insurance in Village India," University of Chicago - Population Research Center 91-3a, Chicago - Population Research Center.
  12. Karsten Jeske, 2006. "Private International Debt with Risk of Repudiation," Journal of Political Economy, University of Chicago Press, vol. 114(3), pages 576-593, June.
  13. Nelson, J.A., 1993. "On Testing for Full Insurance Using Consumer Expenditures Survey Data," Papers 93-02, California Davis - Institute of Governmental Affairs.
  14. Hayashi, Fumio & Altonji, Joseph & Kotlikoff, Laurence, 1996. "Risk-Sharing between and within Families," Econometrica, Econometric Society, vol. 64(2), pages 261-94, March.
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