Implications of Endogenous Group Formation for Efficient Risk‐Sharing

Tessa Bold

Economic Journal, 2009, vol. 119, issue 536, 562-591

Abstract: The existing literature on sub‐game perfect risk‐sharing suffers from a basic inconsistency. While a group of size n is able to coordinate on a risk‐sharing outcome, it is assumed that deviating subgroups cannot. I relax this assumption and characterise the optimal contract among all coalition‐proof history‐dependent contracts. This alters the predictions of the standard dynamic limited commitment model. I show that the consumption of constrained agents depends on both the history of shocks and its interaction with the current income of other constrained agents. From this, I derive a formal test for the presence of endogenous group formation under limited commitment.

Date: 2009
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