Group insurance and lending with endogenous social collateral

We construct a dynamic model of self-enforcing insurance provision and lending to a community of borrowers who are connected by risk-sharing arrangements that are themselves subject to enforcement problems, as in Kocherlakota (1996). We show that an outside lender offering constant-consumption contracts can earn a higher profit if he conditions his repeated interactions with each borrower on the history of his interactions with all the group members (a joint liability contract), rather than on his history with that borrower only (individual liability contracts). This result holds even in the absence of informational asymmetries. The observation driving it is that with individual liability contracts, a joint welfare-maximizing group may prefer to have one or more group members default on their contracts, so that the group can consume a mix of outside funds and the defaulters' stochastic income. One contribution of our work is to give precise economic content to the concept of “social collateral” as the per-agent surplus from group risk-sharing over autarky. The group can deter its members from defaulting on their contracts with the principal by threatening to reduce that surplus.     

Informal insurance in social networks

This paper studies bilateral insurance schemes across networks of individuals. While transfers are based on social norms, individuals must have the incentive to comply. We investigate the structure of self-enforcing insurance networks. Network links play two distinct and possibly conflictual roles. They act as conduits for both transfers and information; affecting the scope for insurance and the severity of punishments upon noncompliance. Their interaction leads to a characterization of stable networks as suitably “sparse” networks. Thickly and thinly connected networks tend to be stable, whereas intermediate degrees of connectedness jeopardize stability. Finally, we discuss the effect of discounting on stability.     

Coalition-Proof Nash Equilibria I. Concepts

In an important class of “noncooperative” environments, it is natural to assume that players can freely discuss their strategies, but cannot make binding commitments. In such cases, any meaningful agreement between the players must be self-enforcing. Although the Nash best-response property is a necessary condition for self-enforceability, it is not sufficient—it is in general possible for coalitions arrange plausible, mutually beneficial deviations from Nash agreements. We provide a stronger definition of self-enforceability, and label the class of efficient self-enforcing agreements “coalition-proof.”     

Risk-sharing networks and insurance against illness

Most risk-sharing tests on developing country data are conducted at the level of the village; generally, the full risk-sharing hypothesis is rejected. This paper uses detailed data on all insurance networks within a village in Tanzania; networks are not clustered but largely overlapping. We test whether full risk-sharing occurs within these networks. While village level full-insurance cannot be rejected for food consumption, we find evidence consistent with at least partial insurance of non-food consumption via networks.     

LIMITED COMMITMENT MODELS OF THE LABOUR MARKET

We present an overview of models of long-term self-enforcing labour contracts in which risk-sharing is the dominant motive for contractual solutions. A base model is developed that is sufficiently general to encompass the two-agent problem central to most of the literature, including variable hours. We consider two-sided limited commitment and look at its implications for aggregate labour market variables. We consider the implications for empirical testing and the available empirical evidence. We also consider the one-sided limited commitment problem for which there exists a considerable amount of empirical support.     

Risk-sharing networks and insurance against illness

Most risk-sharing tests on developing country data are conducted at the level of the village; generally, the full risk-sharing hypothesis is rejected. This paper uses detailed data on all insurance networks within a village in Tanzania; networks are not clustered but largely overlapping. We test whether full risk-sharing occurs within these networks. While village level full-insurance cannot be rejected for food consumption, we find evidence consistent with at least partial insurance of non-food consumption via networks.     

Mutual Insurance,Individual Savings,and Limited Commitment

We examine a dynamic model of mutual insurance when households can also engage in self-insurance by storage. We assume that there is no enforcement mechanism, so that any insurance is informal and must be self-enforcing. We show that consumption allocations satisfy a modified Euler condition and that an enhanced storage technology can either improve or diminish welfare. Furthermore we show that the ex ante transfers introduced into dynamic informal insurance models recently by Gauthier et al. (Gauthier, C., Poitevin, M., and González, P. (1997). Journal of Economic Theory76, 106–144) are only used here in the first period, with the role of ex ante transfers being replaced by differential individual storage. Journal of Economic Literature Classification Numbers: C61, C73, D90, E21.     

Defining residual risk-sharing opportunities: Pooling world income components

We construct a new method of decomposing the variance of national incomes into components in such a way as to indicate the most important ‘residual’ risk-sharing opportunities among peoples of the world. The risk-sharing opportunities we study are nonsystematic risk-sharing opportunities. These are the risk-sharing opportunities that would remain if systematic risk were already shared, see 2. The new method developed here uses a simpler approach to deriving the components based on pure variance reduction. With the new method, the income component securities are derived in terms of eigenvectors of a transformed variance matrix of world incomes, but with this method, the transformation is to use the residuals when incomes are regressed on world income instead of deviations of incomes from average world income as in 3. The method is applied using 16 data on national incomes for large countries 1950–1990, using two different methods of estimating variances.     

On the empirics of risk-sharing across MENA countries

In this article, we compute the potential welfare gains and the realized gains from risk-sharing among Middle East and North African (MENA) countries, including the oil-rich Gulf region and the resource-scarce economies. We find that the overall potential welfare gains across MENA countries are positive for all countries under the assumption of full risk-sharing. The potential welfare gains among the six Gulf Cooperation Council (GCC) countries are positive even though the magnitudes are smaller compared to those of the rest of the MENA region. We also quantify the extent of risk-sharing for the MENA region and show that it is significant for the MENA region and its subgroups; however, we could not find any sign of inter-temporal smoothing across the same groups. Decomposing the aggregate output shocks shows that the extent of risk-sharing is significant when only positive output shocks exist across the resource-scarce MENA economies. However, we observe that GCC countries share output risks with each other even under negative output shocks.     

Implications of Endogenous Group Formation for Efficient Risk-Sharing

The existing literature on sub-game perfect risk-sharing suffers from a basic inconsistency. While a group of size n is able to coordinate on a risk-sharing outcome, it is assumed that deviating subgroups cannot. I relax this assumption and characterise the optimal contract among all coalition-proof history-dependent contracts. This alters the predictions of the standard dynamic limited commitment model. I show that the consumption of constrained agents depends on both the history of shocks and its interaction with the current income of other constrained agents. From this, I derive a formal test for the presence of endogenous group formation under limited commitment.     

Risk-sharing networks

This paper considers the formation of risk-sharing networks. Following empirical findings, we build a model where pairs form links, but a population cannot coordinate links. As a benchmark, individuals commit to share monetary holdings equally with linked partners. We find efficient networks can (indirectly) connect all individuals and involve full insurance. But equilibrium networks connect fewer individuals. When breaking links, individuals do not consider negative externalities on others in the network. Thus identical individuals can end up in different positions in a network and have different outcomes. These results may help to explain empirical findings that risk-sharing is often asymmetric.     

Consumption risk-sharing under terror shocks: Evidence from value-chain network rosters in Nigeria

Households in Nigeria live in inherently risky environments; accentuated by the preponderance of terror incidences, banditry, and farmer–herder-related clashes that are more concentrated in the northern than southern parts of the country. This study examines the proposition that households with a robust network roster—especially networks related to ethnicities and financial remittances from outside their communities—are better able to weather the idiosyncratic and aggregate impact of terror-related shocks; and thus, experience less consumption variability to terror-related shock than other similar households without the “insurance” of an external network. Our main empirical strategy applies a panel difference-in-differences specification to three waves of the LSMS-ISA surveys for Nigeria. The results from the study indicate that having external networks outside the community is an important coping mechanism for terror-related shocks, both for overall welfare and food consumption. The difference in consumption variability between groups with outside network “insurance” and those without could be as high as 20 percentage points. Thus, risk-sharing arrangements for households should exploit outside network insurance mechanisms to mitigate welfare losses from terror-related shocks.     

Regional Insurance and Migration

A dynamic model of migration is developed to study whether labor mobility can hedge people against region-specific shocks, making private or public insurance redundant. The model adopts a novel timing for migration, which is argued to be the time frame suitable for analyzing risk-sharing issues. It also innovates on the existing literature by solving individual migration through convexification of the set of actions. The results show that the role of migration as an insurance mechanism is small: labor mobility cannot fully remove income differentials between regions. It is also shown that a fiscal stabilization scheme is, in general, optimal; moreover, any pure risk-sharing mechanism has no influence on migration flows.     

Endogenous market incompleteness without market frictions: Dynamic suboptimality of competitive equilibrium in multiperiod overlapping generations economies

In this paper, we show that within the set of stochastic three-period-lived OLG economies with productive assets (such as land), markets are necessarily sequentially incomplete, and agents in the model do not share risk optimally. We start by characterizing perfect risk-sharing and find that it requires state-dependent consumption claims which depend only on the exogenous shock realizations. We show then that the recursive competitive equilibrium of any overlapping generations economy with weakly more than three generations is not strongly stationary. This then allows us to show directly that there are short-run Pareto improvements possible in terms of risk-sharing and hence, that the recursive competitive equilibrium is not Pareto optimal. We then show that a financial reform which eliminates the equity asset and replaces it with zero net supply insurance contracts (Arrow securities) will implement to Pareto optimal stochastic steady-state known to exist in the model. Finally, we also show via numerical simulations that a system of government taxes and transfers can lead to a Pareto improvement over the competitive equilibrium in the model.     

Diversity and the disinterest in trade liberalization: on the prospects of self-enforcing cooperation

International economic order, including the rules of the game for trade, usually suffers from enforcement problems. We examine the prospects of self-enforcing cooperation as trade relationships evolve. It turns out that factor differentials and specificities are of utmost importance. In fact, prospects of self-enforcing cooperation are the lower the more diverse the countries are on that score. Differences may even result in countries showing an outright disinterest in trade liberalization. Notably, this result also holds in a recurrent, that is, in an evolutionary setting that otherwise induces cooperation in trade liberalization with self-enforcing properties.     

Attitudes towards euro area reforms: Evidence from a randomized survey experiment

This paper provides insights into the determinants of euro area reform preferences by means of a randomized survey experiment in Germany. Respondents are confronted with a pro and a contra argument to reform proposals on a European Unemployment Benefit Scheme and a Sovereign Insolvency Procedure, respectively, with the contra argument being varied across respondents. Our results for the control group suggest that there is a low willingness to accept fiscal risk-sharing through common unemployment insurance, while a sovereign insolvency procedure aimed at strengthening market discipline is supported by a majority of the survey participants. Our randomized treatments highlighting specific potential adverse effects of the reforms lead to significant downward shifts in approval rates. Altruism, EU support, nationalism, political preferences and income are important predictors of support for the reform proposals. We also show that there is a striking contrast between the low level of support for transfers to other euro area member states and a broad acceptance of inner German transfers.     

International migration and informal social protection in rural Mozambique

This paper uses a unique household survey from two southern regions in Mozambique to examine the extent to which dispatching family labour abroad is a source of informal social protection for households left behind. We do so by studying the relation between migration, remittances and participation in groups that provide informal social services to migrant-sending communities. We distinguish between a range of community associations related to insurance, credit and production provision and we further correct for the endogenous choice of group membership. Results show that migration associated with remittances increase community group participation. In particular, while there is no significant relationship with group membership related to credit or self-help activities, remittance recipients are more likely to join groups that provide insurance. These findings point to the role of migration as a source of social protection for migrant-sending communities at origin.     

Pareto-improving firing costs?

We examine self-enforcing contracts between risk-averse workers and risk-neutral firms (the ‘invisible handshake’) in a labor market with search frictions. Employers promise as much wage-smoothing as they can, consistent with incentive conditions that ensure they will not renege during low-profitability times. Equilibrium is inefficient if these incentive constraints bind, with risky wages for workers and a risk premium that employers must pay. Mandatory firing costs can help, by making it easier for employers to promise credibly not to cut wages in low-profitability periods. We show that firing costs are more likely to be Pareto-improving if they are not severance payments.     

Community rating and the market for private non-group health insurance

Prior research on adverse selection in health insurance markets has found only mixed evidence for adverse selection in group settings. We examine the impact of state community rating regulations enacted in the 1990s, which greatly limited insurers' ability to risk rate premiums, to determine if adverse selection is more evident in non-group insurance markets. Using data from large, national surveys we find evidence of a shift to a less healthy pool of non-group enrollees as a consequence of community rating. Community rating made healthy people 20 to 60% less likely to be insured by non-group health insurance; in addition, we found evidence that young and healthy people were 20 to 30% more likely to be uninsured as a result of community rating. We also find evidence that individuals in poor health were 35 to 50% more likely to be insured in the non-group market, but only limited evidence suggesting that persons in poor health were less likely to be uninsured. Our results are further supported by findings suggesting that non-group enrollees were sicker as a result of the community rating laws. Lastly, we find evidence suggesting that HMO penetration in the non-group market increased disproportionately in states that implemented community rating relative to states that did not.     

The crowding-out effect of formal insurance on informal risk sharing: An experimental study

This paper investigates the crowding-out effect of formal insurance on informal risk-sharing arrangements via theory and laboratory experiment. Our model and simulation predict that the crowding out of private transfers is often more than one-for-one and will reduce the total risk coverage. Furthermore, the existence of a moderate degree of altruism exaggerates the crowding-out effect, especially when there is an ex-ante income inequality. These predictions are mostly supported by the laboratory experiment, except that the crowding-out effect is not more than one-for-one, and hence the total risk coverage is not significantly reduced by formal insurance.