Risk Sharing Externalities
Luigi Bocola and
Guido Lorenzoni
No 26985, NBER Working Papers from National Bureau of Economic Research, Inc
Abstract:
Financial crises typically arise because firms and financial institutions choose balance sheets that expose them to aggregate risk. We propose a theory to explain these risk exposures. We study a financial accelerator model where entrepreneurs can issue state-contingent claims to consumers. Even though entrepreneurs could use these contingent claims to hedge negative shocks, we show that they tend not to do so. This is because it is costly to buy insurance against these shocks as consumers are also harmed by them. This effect is self-reinforcing, as the fact that entrepreneurs are unhedged amplifies the negative effects of shocks on consumers’ incomes. We show that this feedback can be quantitatively important and lead to inefficiently high risk exposure for entrepreneurs.
JEL-codes: E44 G01 G11 (search for similar items in EconPapers)
Date: 2020-04
New Economics Papers: this item is included in nep-ent, nep-mac and nep-rmg
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Citations: View citations in EconPapers (4)
Published as Luigi Bocola & Guido Lorenzoni, 2023. "Risk-Sharing Externalities," Journal of Political Economy, vol 131(3), pages 595-632.
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