Risk-Sharing in Village Economies Revisited

66 Pages Posted: 18 Apr 2016

See all articles by Tessa Bold

Tessa Bold

Stockholm University - Institute for International Economic Studies (IIES)

Tobias Broer

Stockholm University; Centre for Economic Policy Research (CEPR)

Date Written: March 2016

Abstract

The limited commitment model is popular for the analysis of village risk-sharing as it captures both the observed partial character of insurance and the presumption that incomes are well observed but formal contracts absent in rural communities. We study dynamic limited commitment when individuals can form new, smaller coalitions after reneging in a larger group, which makes group size an endogenous outcome of the model. This is important for theoretical consistency, but also because we show that enforcement constraints, which typically bind only in case of positive income shocks, counterfactually imply a stronger response of consumption to income increases than to income losses in village-size insurance groups. In small groups, in contrast, the response of consumption to income increases and declines is symmetric. The results show how equilibrium group sizes are much smaller than the typical village, bringing the predicted consumption process in line with the data. We thus argue that allowing for endogenous group formation in the dynamic limited commitment model strongly improves its predictive power for analyzing risk-sharing in village economies.

Keywords: Dynamic Limited Commitment, Informal Insurance, Renegotiation-Proofness, Risk-Sharing, Village Economies

JEL Classification: D11, D12, D52

Suggested Citation

Bold, Tessa and Broer, Tobias, Risk-Sharing in Village Economies Revisited (March 2016). CEPR Discussion Paper No. DP11143, Available at SSRN: https://ssrn.com/abstract=2766434

Tessa Bold (Contact Author)

Stockholm University - Institute for International Economic Studies (IIES) ( email )

Stockholm, SE-10691
Sweden

Tobias Broer

Stockholm University ( email )

Universitetsvägen 10
Stockholm, Stockholm SE-106 91
Sweden

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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