Heterogeneity and the Formation of Risk-Sharing Coalitions

We study the relationship between the distribution of individuals' attributes over the population and the extent of risk sharing in a risky environment. We consider a society where individuals differing with respect to risk or their degree of risk aversion form risk-sharing coalitions in the absence of financial markets. We obtain a partition belonging to the core of the membership game. It is homophily-based: the less risky (or the more risk tolerant) agents congregate together and reject more risky ones (or less risk tolerant ones) into other coalitions. The distribution of risk or risk aversion affects the number and the size of these coalitions. It turns out that individuals may pay a lower risk premium in more risky societies. We also show that a higher heterogeneity in risk or risk aversion leads to a lower degree of partial risk-sharing. The empirical evidence on partial risk sharing can be understood when the endogenous partition of society into risk-sharing coalitions is taken into account.