Implications of Endogenous Group Formation for Efficient Risk-Sharing

Tessa Bold

No 387, Economics Series Working Papers from University of Oxford, Department of Economics

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.

Keywords: Risk-Sharing; Limited Commitment; Endogenous Group Formation (search for similar items in EconPapers)
JEL-codes: C72 D02 D86 (search for similar items in EconPapers)
Date: 2008-02-01
New Economics Papers: this item is included in nep-bec and nep-gth
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