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Formal and Informal Risk Sharing in LDCs: Theory and Empirical Evidence

49 Pages Posted: 28 Jun 2007  

Pierre Dubois

University of Toulouse 1 - Toulouse School of Economics (TSE)

Bruno Jullien

University of Toulouse 1 - Toulouse School of Economics (TSE); University of Toulouse 1 - Groupe de Recherche en Economie Mathématique et Quantitative (GREMAQ); Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute)

Thierry Magnac

Toulouse School of Economics; University of Toulouse 1 - Industrial Economic Institute (IDEI); IZA Institute of Labor Economics; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: January 2007

Abstract

We develop and estimate a model of dynamic interactions where commitment is limited and contracts are incomplete to explain the patterns of income and consumption growth in village economies of less developed countries. Households can insure through both formal contracts and informal agreements, that is, agreements specifying voluntary transfers that need to be self-enforceable. This theoretical setting nests the case of complete markets and the case where only informal agreements are available. We derive a system of non-linear equations for income and consumption growth. A key prediction of our model is that both variables are affected by lagged consumption as a consequence of the interplay of formal and informal contracting possibilities. In a semi-parametric setting, we prove identification, derive testable restrictions and estimate the model with the use of data from Pakistan villages. Empirical results are consistent with the economic arguments. Incentive constraints due to self-enforcement bind with positive probability and formal contracts are used to reduce this probability.

Keywords: Contracts, Incomplete Markets, Informal Transfers, Risk sharing

JEL Classification: C14, D13, D91, L14, O12

Suggested Citation

Dubois, Pierre and Jullien, Bruno and Magnac, Thierry, Formal and Informal Risk Sharing in LDCs: Theory and Empirical Evidence (January 2007). CEPR Discussion Paper No. 6060. Available at SSRN: https://ssrn.com/abstract=997115

Pierre Dubois (Contact Author)

University of Toulouse 1 - Toulouse School of Economics (TSE) ( email )

Place Anatole-France
Toulouse Cedex, F-31042
France

Bruno Jullien

University of Toulouse 1 - Toulouse School of Economics (TSE) ( email )

Place Anatole-France
Toulouse Cedex, F-31042
France

University of Toulouse 1 - Groupe de Recherche en Economie Mathématique et Quantitative (GREMAQ) ( email )

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Centre for Economic Policy Research (CEPR)

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CESifo (Center for Economic Studies and Ifo Institute)

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Munich, DE-81679
Germany

Thierry Magnac

Toulouse School of Economics ( email )

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21 Allees de Brienne
Toulouse, 31000
France

University of Toulouse 1 - Industrial Economic Institute (IDEI) ( email )

Manufacture des Tabacs
21 Allee de Brienne bat. F
Toulouse Cedex, F-31000
France

IZA Institute of Labor Economics ( email )

P.O. Box 7240
Bonn, D-53072
Germany

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
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