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

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Author Info
Dubois, Pierre / Jullien, Bruno / Magnac, Thierry

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Abstract

We develop and estimate a model of dynamic interactions in which 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 each other through both formal contracts and informal agreements, that is, self-enforcing agreements specifying voluntary transfers. 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.

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Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number CESifo Working Paper No. 2184.

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Date of creation: 2008
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Handle: RePEc:ces:ceswps:_2184

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Keywords: risk sharing; contracts; incomplete markets; informal transfers;

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Dubois, Pierre / Jullien, Bruno / Magnac, Thierry, 2008. "Formal and Informal Risk Sharing in LDCs: Theory and Empirical Evidence," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
    Other versions:
  2. Jonathan P Thomas & Tim Worrall, 2007. "Limited Commitment Models of the Labour Market," Keele Economics Research Papers KERP 2007/11, Centre for Economic Research, Keele University. [Downloadable!]
    Other versions:
  3. Notten, Geranda & Neubourg, Chris de, 2007. "Managing risks: what Russian households do to smooth consumption?," MPRA Paper 4670, University Library of Munich, Germany. [Downloadable!]
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