Insuring uninsurable income

Michiko Ogaku

Papers from arXiv.org

Abstract: In an exchange economy composed of risk-averse individuals subject to shocks, these shocks may become uninsurable if they are private information. Efficient smoothing of such shocks across the economy requires to self-report the shocks they privately experience. This efficient allocation often leads to growing inequality, a problem that remains largely unresolved. This paper extends an alternative mechanism proposed by Marcet and Marimon (1992, JET), which redistributes risk across periods for the same individual. This approach could reduce the inequality observed in previous studies that allocate risk among individuals within each period. Marcet and Marimon's mechanism, originally designed as an efficient growth mechanism combining state-contingent investment and transfers, is used here to facilitate transfers in an exchange economy subject to income shocks. The first key finding of this paper is that the proposed mechanism can achieve both efficiency and avoidance of immiserization under certain conditions, specifically, when individuals' degree of risk aversion is not excessively high relative to the disparity between their highest and lowest possible incomes. Furthermore, the mechanism preserves equality of opportunity within the same age group. Where efficiency and equality of opportunity are achieved by shifting risks to future periods. Even if the sufficient condition is not met, the mechanism ensures the optimal allocation under the given condition and continues to avoid immiserization. The second key finding concerns to the potential sustainability of this mechanism in a society with a continuum of individuals, where the population, consisting of different age group, remains constant over time.

Date: 2022-04, Revised 2025-03
New Economics Papers: this item is included in nep-ias
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