Trust in risk sharing: A double-edged sword

Harold Cole, Dirk Krueger, George Mailath and Yena Park

No 697, CFS Working Paper Series from Center for Financial Studies (CFS)

Abstract: We analyze efficient risk-sharing arrangements when the value from deviating is determined endogenously by another risk sharing arrangement. Coalitions form to insure against idiosyncratic income risk. Self-enforcing contracts for both the original coalition and any coalition formed (joined) after deviations rely on a belief in future cooperation which we term "trust". We treat the contracting conditions of original and deviation coalitions symmetrically and show that higher trust tightens incentive constraints since it facilitates the formation of deviating coalitions. As a consequence, although trust facilitates the initial formation of coalitions, the extent of risk sharing in successfully formed coalitions is declining in the extent of trust and efficient allocations might feature resource burning or utility burning: trust is indeed a double-edged sword.

Keywords: Coalitions; Limited Enforcement; Risk Sharing (search for similar items in EconPapers)
JEL-codes: D11 D91 E21 G22 (search for similar items in EconPapers)
Date: 2023
New Economics Papers: this item is included in nep-cta and nep-rmg
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https://www.econstor.eu/bitstream/10419/268899/1/1837931178.pdf (application/pdf)

Related works:
Journal Article: Trust in Risk Sharing: A Double-Edged Sword (2024)
Working Paper: Trust in Risk Sharing: A Double-Edged Sword (2020)
Working Paper: Trust in Risk Sharing: A Double-Edged Sword (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:cfswop:697

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