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Risk sharing, investment, and incentives in the neoclassical growth model

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  • Emilio Espino
  • Juan M. Sanchez

Abstract

We first study growth and risk sharing in a stochastic growth model with preference shocks and two risk-averse agents. In periods in which one of the agents needs extra consumption (insurance), it is socially optimal to reduce the consumption of the other agent (redistribution) and also to accumulate fewer resources for the future (disinvestment). The latter hurts growth while the former only affects the distribution of aggregate consumption. Then, to analyze if information matters, we study if the same allocation would be implementable under private information. We find that it depends on the state of the economy. The provision of insurance that is implemented by reducing capital accumulation deteriorates the prospects of all agents in the economy and thus helps to alleviate informational frictions. The size of redistribution versus disinvestment and the outlook of economic growth at the time of disinvestment affects the possibilities of implementing the best possible allocation when the preference shock is private information. Therefore, we conjecture that under private information the best allocation compatible with incentives would tend to hurt growth and to concentrate resources in agents with private information in order to provide incentives to report the shock truthfully.

Suggested Citation

  • Emilio Espino & Juan M. Sanchez, 2010. "Risk sharing, investment, and incentives in the neoclassical growth model," Economic Quarterly, Federal Reserve Bank of Richmond, vol. 96(4Q), pages 399-416.
    • Handle: RePEc:fip:fedreq:y:2010:i:4q:p:399-416:n:v.96no.4
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    References listed on IDEAS

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    1. Jeremy Greenwood & Juan M. Sanchez & Cheng Wang, 2010. "Financing Development: The Role of Information Costs," American Economic Review, American Economic Association, vol. 100(4), pages 1875-1891, September.
    2. Espino, Emilio, 2005. "On Ramsey's conjecture: efficient allocations in the neoclassical growth model with private information," Journal of Economic Theory, Elsevier, vol. 121(2), pages 192-213, April.
    3. Hall, Robert E, 1997. "Macroeconomic Fluctuations and the Allocation of Time," Journal of Labor Economics, University of Chicago Press, vol. 15(1), pages 223-250, January.
    4. Jeremy Greenwood & Juan Sanchez & Cheng Wang, 2013. "Quantifying the Impact of Financial Development on Economic Development," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 16(1), pages 194-215, January.
    5. Khan, Aubhik & Ravikumar, B., 2001. "Growth and risk-sharing with private information," Journal of Monetary Economics, Elsevier, vol. 47(3), pages 499-521, June.
    6. Wang, Cheng, 1997. "Incentives, CEO Compensation, and Shareholder Wealth in a Dynamic Agency Model," Journal of Economic Theory, Elsevier, vol. 76(1), pages 72-105, September.
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    8. Thomas, Jonathan & Worrall, Tim, 1990. "Income fluctuation and asymmetric information: An example of a repeated principal-agent problem," Journal of Economic Theory, Elsevier, vol. 51(2), pages 367-390, August.
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    Cited by:

    1. Jeremy Greenwood & Juan Sanchez & Cheng Wang, 2013. "Quantifying the Impact of Financial Development on Economic Development," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 16(1), pages 194-215, January.
    2. Wang, Cheng, 1997. "Incentives, CEO Compensation, and Shareholder Wealth in a Dynamic Agency Model," Journal of Economic Theory, Elsevier, vol. 76(1), pages 72-105, September.
    3. Josef Schroth, 2015. "Risk Sharing in the Presence of a Public Good," Staff Working Papers 15-27, Bank of Canada.

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    Economic growth; Business cycles;

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