On attenuation of moral hazard in risk sharing in poor urban economies

This paper examines how risk sharing is shaped by moral hazard and enforcement concerns. The existing literature mostly looks at each concern in isolation and misses out on an interesting tradeoff between insurance and production (effort) that is introduced by jointly incorporating moral hazard and enforcement problems. We show that self-enforcement of contracts requires reduced insurance which in turn softens the moral hazard stance, thereby enhancing effort. Households therefore work harder and produce more output, though they are less insured. This offers an explanation of why informal risk sharing persists despite potentially significant monitoring and enforcement difficulties.