Informal Risk-Sharing in an Infinite-Horizon Experiment

41 Pages Posted: 1 Mar 2004

See all articles by Gary Charness

Gary Charness

University of California, Santa Barbara (UCSB) - Department of Economics

Garance Genicot

Georgetown University - Department of Economics

Date Written: June 2006

Abstract

This paper presents the first laboratory study of risk-sharing without commitment. Our experiment captures the main features of a simple model of voluntary insurance between two agents. In the model, two individuals interact over a potential infinite horizon and suffer random income shocks. Risk-averse individuals have incentives to smooth consumption by making transfers to each other. These transfers being voluntary, only self-enforcing risk-sharing arrangements are possible: transfers can never be so large as to tempt individuals to renege on them. This constraint, when binding, has strong implications for the shape of the constrained optimal risk-sharing arrangement.

In our experiment, participants are matched in pairs. Each period, one of them, randomly drawn, receives a given amount h in addition to its regular income. After observing both incomes, each person in a pair chooses a non-negative transfer to make to the other person. Two features of the experimental design are crucial. First, it is common information that all pairs will be dissolved at the end of each period with a given probability. Participants are informed when this occurs and randomly re-matched. This replicates the effect of infinite-horizon and discounting in the model. Second, at the end of the experiment, a unique period is randomly drawn to count for cash payment. This feature is essential to isolate for the utility outcome of each period.

We find evidence generally consistent with risk sharing, with higher transfers coming from individuals who received h in the period. Moreover, in support of the theory, transfers are much higher with a higher continuation probability and they also are highly correlated with the individual's degree of risk aversion. However, while the model predicts an increase in transfers with ex ante inequality, we observe the opposite effect. This may reflect considerations of identity or group membership.

Keywords: Experiments, gift exchange, informal insurance, risk-sharing, social preferences

JEL Classification: A49, C91, C92, D31, D81, O17

Suggested Citation

Charness, Gary and Genicot, Garance, Informal Risk-Sharing in an Infinite-Horizon Experiment (June 2006). Available at SSRN: https://ssrn.com/abstract=510862 or http://dx.doi.org/10.2139/ssrn.510862

Gary Charness (Contact Author)

University of California, Santa Barbara (UCSB) - Department of Economics ( email )

2127 North Hall
Santa Barbara, CA 93106
United States
805-893-2412 (Phone)
805-893-8830 (Fax)

Garance Genicot

Georgetown University - Department of Economics ( email )

Washington, DC 20057
United States
202-687-7144 (Phone)
202-687-6102 (Fax)

HOME PAGE: http://www.georgetown.edu/faculty/gg58

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
218
Abstract Views
2,580
rank
176,324
PlumX Metrics