Insuring uninsurable income

Michiko Ogaku

Papers from arXiv.org

Abstract: We study dynamic mechanism design in a pure-exchange economy with privately observed idiosyncratic income. Classic hidden-income contracts attain constrained efficiency only at the cost of immiseration (Green 1987; Thomas-Worrall 1990). We propose a simple recursive mechanism adapted from Marcet-Marimon (1992) that shifts each income shock forward by one period, keeps promised utilities in a bounded set, and, under a transparent ``moderate risk-aversion'' condition, delivers sequential efficiency. In a stationary overlapping-generations setting, we further provide an explicit condition on the initial promise that ensures budget sustainability; early cohorts pre-fund intertemporal smoothing so that every cohort attains a higher expected lifetime utility than under autarky. Our analysis uses a single state (promised utility), closed-form transfers, and a Bellman verification.

Date: 2022-04, Revised 2025-08
New Economics Papers: this item is included in nep-ias
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