Dynamic Risk Sharing with Prepayment

Alexander Karaivanov ()
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Alexander Karaivanov: Simon Fraser University, https://www.sfu.ca/~akaraiva/

Discussion Papers from Department of Economics, Simon Fraser University

Abstract: I analyze the role of prepayment in a dynamic risk-sharing setting with information and commitment frictions. An insurance platform contracts with a risk-averse agent with stochastic income. Part of the income can be withheld in escrow as a prepayment. I consider three endogenously incomplete markets settings with different obstacles to risk sharing: limited commitment, private information due to hidden income, and both. I show that prepayment alleviates the limited commitment problem and improves the degree of risk sharing, including possibly to full insurance depending on the model parameters; however, prepayment is ineffective in the private information settings. In the setting with both limited commitment and private information frictions, I show that private information is the binding constraint.

Date: 2026-03
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