Sharing Risk Efficiently under Suboptimal Punishments for Defection

Drew Saunders ()

Purdue University Economics Working Papers from Purdue University, Department of Economics

Abstract: The paper studies efficient risk sharing under limited enforcement (or "limited commitment") constraints determined by the threat of punishment after misbehavior. As in Kocherlakota (1996), I assume that society chooses from among those allocations implementable in subgame perfect equilibrium. Rather than assume that punishments implement the least desirable continuation equilibrium, I allow that punishments may be suboptimally specified from the point of view of enforcement. I characterize (up to a technical condition) the set of allocations that may be interpreted as efficient subject to enforcement by some punishment. The conditions rationalizing such efficiency are very weak; they are (i) resource exhaustion, (ii) satisfaction of individual rationality constraints at each continuation, and (iii) fniteness of the value of the allocation under the implicit decentralizing price system, the "high implied interest rates" condition of Alvarez and Jermann (2000). I show that efficient allocations may be decentralized and I state versions of the Welfare Theorems for my environment.

Pages: 38 pages
Date: 2007-08
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Related works:
Journal Article: Sharing Risk Efficiently under Suboptimal Punishments for Defection (2010)
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Persistent link: https://EconPapers.repec.org/RePEc:pur:prukra:1203

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