Competitive Risk Sharing Contracts with One-Sided Commitment

35 Pages Posted: 26 Feb 2004

See all articles by Dirk Krueger

Dirk Krueger

University of Pennsylvania - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Harald Uhlig

University of Chicago - Department of Economics

Multiple version iconThere are 3 versions of this paper

Date Written: January 2004

Abstract

This Paper analyses dynamic equilibrium risk sharing contracts between profit-maximizing intermediaries and a large pool of ex-ante identical agents that face idiosyncratic income uncertainty that makes them heterogeneous ex-post. In any given period, after having observed their income, the agent can walk away from the contract, while the intermediary cannot, i.e., there is one-sided commitment. We consider the extreme scenario that the agents face no costs to walking away, and can sign up with any competing intermediary without any reputational losses. Contrary to intuition, we demonstrate that not only autarky, but also partial and full insurance can obtain, depending on the relative patience of agents and financial intermediaries. Insurance can be provided because in an equilibrium contract an up-front payment effectively locks in the agent with an intermediary. We then show that our contract economy is equivalent to a consumption-savings economy with one-period Arrow securities and a short-sale constraint, similar to Bulow and Rogo (1989). From this equivalence and our characterization of dynamic contracts it immediately follows that without cost of switching financial intermediaries debt contracts are not sustainable, even though a risk allocation superior to autarky can be achieved.

JEL Classification: D11, D91, E21, G22

Suggested Citation

Krueger, Dirk and Uhlig, Harald, Competitive Risk Sharing Contracts with One-Sided Commitment (January 2004). Available at SSRN: https://ssrn.com/abstract=509503

Dirk Krueger

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
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Philadelphia, PA 19104-6297
United States
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HOME PAGE: http://www.econ.upenn.edu/~dkrueger/

National Bureau of Economic Research (NBER)

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Centre for Economic Policy Research (CEPR)

London
United Kingdom

Harald Uhlig (Contact Author)

University of Chicago - Department of Economics ( email )

1101 East 58th Street
Chicago, IL 60637
United States

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