IDEAS home Printed from https://ideas.repec.org/a/oup/restud/v91y2024i3p1448-1497..html
   My bibliography  Save this article

Trust in Risk Sharing: A Double-Edged Sword

Author

Listed:
  • Harold L Cole
  • Dirk Krueger
  • George J Mailath
  • Yena Park

Abstract

We analyse efficient risk-sharing arrangements when the value from deviating is determined endogenously by another risk-sharing arrangement. Coalitions form to insure against idiosyncratic income risk. Self-enforcing contracts for both the original coalition and any coalition formed (joined) after deviations rely on a belief in future cooperation which we term “trust”. We treat the contracting conditions of original and deviation coalitions symmetrically and show that higher trust tightens incentive constraints since it facilitates the formation of deviating coalitions. As a consequence, although trust facilitates the initial formation of coalitions, the extent of risk sharing in successfully formed coalitions is declining in the extent of trust and efficient allocations might feature resource burning or utility burning: trust is indeed a double-edged sword.

Suggested Citation

  • Harold L Cole & Dirk Krueger & George J Mailath & Yena Park, 2024. "Trust in Risk Sharing: A Double-Edged Sword," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 91(3), pages 1448-1497.
    • Handle: RePEc:oup:restud:v:91:y:2024:i:3:p:1448-1497.
    as

    Download full text from publisher

    File URL: http://hdl.handle.net/10.1093/restud/rdad071
    Download Restriction: Access to full text is restricted to subscribers.
    ---><---

    As the access to this document is restricted, you may want to look for a different version below or search for a different version of it.

    Other versions of this item:

    References listed on IDEAS

    as
    1. Ethan Ligon & Jonathan P. Thomas & Tim Worrall, 2002. "Informal Insurance Arrangements with Limited Commitment: Theory and Evidence from Village Economies," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 69(1), pages 209-244.
    2. Stephen Knack & Philip Keefer, 1997. "Does Social Capital Have an Economic Payoff? A Cross-Country Investigation," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 112(4), pages 1251-1288.
    3. Krueger, Dirk & Uhlig, Harald, 2006. "Competitive risk sharing contracts with one-sided commitment," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1661-1691, October.
    4. William Easterly & Ross Levine, 1997. "Africa's Growth Tragedy: Policies and Ethnic Divisions," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 112(4), pages 1203-1250.
    5. Bulow, Jeremy & Rogoff, Kenneth, 1989. "Sovereign Debt: Is to Forgive to Forget?," American Economic Review, American Economic Association, vol. 79(1), pages 43-50, March.
    6. Christopher Udry, 1994. "Risk and Insurance in a Rural Credit Market: An Empirical Investigation in Northern Nigeria," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 61(3), pages 495-526.
    7. Mikhail Golosov & Aleh Tsyvinski, 2006. "Designing Optimal Disability Insurance: A Case for Asset Testing," Journal of Political Economy, University of Chicago Press, vol. 114(2), pages 257-279, April.
    8. Dirk Krueger & Fabrizio Perri, 2006. "Does Income Inequality Lead to Consumption Inequality? Evidence and Theory -super-1," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 73(1), pages 163-193.
    9. Fernando Alvarez & Urban J. Jermann, 2000. "Efficiency, Equilibrium, and Asset Pricing with Risk of Default," Econometrica, Econometric Society, vol. 68(4), pages 775-798, July.
    10. Emmanuel Farhi & Mikhail Golosov & Aleh Tsyvinski, 2009. "A Theory of Liquidity and Regulation of Financial Intermediation," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 76(3), pages 973-992.
    11. Juarez, Laura, 2009. "Crowding out of private support to the elderly: Evidence from a demogrant in Mexico," Journal of Public Economics, Elsevier, vol. 93(3-4), pages 454-463, April.
    12. Woolcock, Michael & Narayan, Deepa, 2000. "Social Capital: Implications for Development Theory, Research, and Policy," The World Bank Research Observer, World Bank, vol. 15(2), pages 225-249, August.
    13. Kehoe, Timothy J & Levine, David K, 2001. "Liquidity Constrained Markets versus Debt Constrained Markets," Econometrica, Econometric Society, vol. 69(3), pages 575-598, May.
    14. Kahn, Charles M. & Mookherjee, Dilip, 1992. "The good, the bad, and the ugly: Coalition proof equilibrium in infinite games," Games and Economic Behavior, Elsevier, vol. 4(1), pages 101-121, January.
    15. Melanie Morten, 2019. "Temporary Migration and Endogenous Risk Sharing in Village India," Journal of Political Economy, University of Chicago Press, vol. 127(1), pages 1-46.
    16. Milton Harris & Bengt Holmstrom, 1982. "A Theory of Wage Dynamics," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 49(3), pages 315-333.
    17. Greif, Avner, 1993. "Contract Enforceability and Economic Institutions in Early Trade: the Maghribi Traders' Coalition," American Economic Review, American Economic Association, vol. 83(3), pages 525-548, June.
    18. Douglas Bernheim, B. & Ray, Debraj, 1989. "Collective dynamic consistency in repeated games," Games and Economic Behavior, Elsevier, vol. 1(4), pages 295-326, December.
    19. Narayana R. Kocherlakota, 1996. "Implications of Efficient Risk Sharing without Commitment," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 63(4), pages 595-609.
    20. Costas Meghir & A Mushfiq Mobarak & Corina Mommaerts & Melanie Morten, 2022. "Migration and Informal Insurance: Evidence from a Randomized Controlled Trial and a Structural Model," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 89(1), pages 452-480.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Juan Daniel Hernandez & Fernando Jaramillo & Hubert Kempf & Fabien Moizeau & Thomas Vendryes, 2023. "Limited Commitment, Social Control and Risk-Sharing Coalitions in Village Economies," Documents de recherche 23-03, Centre d'Études des Politiques Économiques (EPEE), Université d'Evry Val d'Essonne.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Harold L. Cole & Dirk Krueger & George J. Mailath & Yena Park, 2021. "Social Capital: A Double-Edged Sword," ECONtribute Discussion Papers Series 064, University of Bonn and University of Cologne, Germany.
    2. Miao, Jianjun & Zhang, Yuzhe, 2015. "A duality approach to continuous-time contracting problems with limited commitment," Journal of Economic Theory, Elsevier, vol. 159(PB), pages 929-988.
    3. S. Viswanathan & Adriano A. Rampini, 2008. "Collateral, Financial Intermediation, and the Distribution of Debt Capacity," 2008 Meeting Papers 116, Society for Economic Dynamics.
    4. Krueger, Dirk & Perri, Fabrizio, 2011. "Public versus private risk sharing," Journal of Economic Theory, Elsevier, vol. 146(3), pages 920-956, May.
    5. Árpád Ábrahám & Sarolta Laczó, 2018. "Efficient Risk Sharing with Limited Commitment and Storage," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 85(3), pages 1389-1424.
    6. V. Filipe Martins-Da-Rocha & Toan Phan & Yiannis Vailakis, 2022. "Pecuniary Externalities in Competitive Economies with Limited Pledgeability," Working Papers hal-03909596, HAL.
    7. Tobias Broer, 2009. "Stationary equilibrium distributions in economies with limited commitment," Economics Working Papers ECO2009/39, European University Institute.
    8. Mazur, Karol, 2023. "Sharing risk to avoid tragedy: Informal insurance and irrigation in village economies," Journal of Development Economics, Elsevier, vol. 161(C).
    9. Melanie Morten, 2016. "Temporary Migration and Endogenous Risk Sharing in Village India," NBER Working Papers 22159, National Bureau of Economic Research, Inc.
    10. Broer, Tobias, 2014. "Domestic or global imbalances? Rising income risk and the fall in the US current account," Journal of Monetary Economics, Elsevier, vol. 64(C), pages 47-67.
    11. Grochulski, Borys & Zhang, Yuzhe, 2011. "Optimal risk sharing and borrowing constraints in a continuous-time model with limited commitment," Journal of Economic Theory, Elsevier, vol. 146(6), pages 2356-2388.
    12. Alvaro Aguirre, 2017. "Contracting Institutions and Economic Growth," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 24, pages 192-217, March.
    13. Tom Krebs & Moritz Kuhn & Mark Wright, 2016. "Insurance in human capital models with limited enforcement," CAMA Working Papers 2016-48, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    14. Tessa Bold, 2009. "Implications of Endogenous Group Formation for Efficient Risk‐Sharing," Economic Journal, Royal Economic Society, vol. 119(536), pages 562-591, March.
    15. Tom Krebs & Moritz Kuhn & Mark L. J. Wright, 2015. "Human Capital Risk, Contract Enforcement, and the Macroeconomy," American Economic Review, American Economic Association, vol. 105(11), pages 3223-3272, November.
    16. Paal, Beatrix & Wiseman, Thomas, 2011. "Group insurance and lending with endogenous social collateral," Journal of Development Economics, Elsevier, vol. 94(1), pages 30-40, January.
    17. Krueger, Dirk & Uhlig, Harald, 2022. "Neoclassical Growth with Limited Commitment," CEPR Discussion Papers 17757, C.E.P.R. Discussion Papers.
    18. Krueger, Dirk & Uhlig, Harald, 2006. "Competitive risk sharing contracts with one-sided commitment," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1661-1691, October.
    19. Florin Bidian & Camelia Bejan, 2015. "Martingale properties of self-enforcing debt," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 60(1), pages 35-57, September.
    20. Golosov, M. & Tsyvinski, A. & Werquin, N., 2016. "Recursive Contracts and Endogenously Incomplete Markets," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.), Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 725-841, Elsevier.

    More about this item

    Keywords

    Coalitions; Limited enforcement; Risk sharing;
    All these keywords.

    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:oup:restud:v:91:y:2024:i:3:p:1448-1497.. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Oxford University Press (email available below). General contact details of provider: https://academic.oup.com/restud .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.