Trust in Risk Sharing: A Double-Edged Sword

Dirk Krueger, Harold Cole, George Mailath and Yena Park

No 14333, CEPR Discussion Papers from Centre for Economic Policy Research

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; Risk sharing; Limited commitment (search for similar items in EconPapers)
JEL-codes: E20 (search for similar items in EconPapers)
Date: 2020-01
New Economics Papers: this item is included in nep-cta, nep-gth, nep-mac and nep-mic
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Citations: View citations in EconPapers (2)

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Related works:
Journal Article: Trust in Risk Sharing: A Double-Edged Sword (2024)
Working Paper: Trust in risk sharing: A double-edged sword (2023)
Working Paper: Trust in Risk Sharing: A Double-Edged Sword (2020)
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