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Trust in Risk Sharing: A Double-Edged Sword

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  • 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.
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    File URL: http://hdl.handle.net/10.1093/restud/rdad071
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    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.

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    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)

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