Risk Aversion |  |
Description
In most of the developing world, people are exposed to substantial, even catastrophic, risk and mitigating risk is a central concern. A high degree of dependence on agricultural production, widespread poverty and the lack of access to formal insurance and credit, make the need for consumption smoothing particularly acute. Most individuals respond to the large fluctuations in their income by engaging in informal risk-sharing by providing each other with help, gifts and transfers, with some reciprocity expected. There is considerable evidence of the presence of some but limited insurance in village communities (Deaton [1992], Townsend [1994], Udry [1994], Jalan and Ravallion [1999], Ligon, Thomas and Worrall [1999], Grimard [1997], Gertler and Gruber [1997], and Foster and Rosenzweig [2002]). The most important limitation appears to arise from the lack of enforceability of risk-sharing agreements. The fact that these agreements must be designed to elicit voluntary participation often seriously limits the extent of insurance they can provide. There is a growing theoretical literature on self-enforcing risk-sharing agreements. Some important theoretical contributions are Kimball [1988], Coate and Ravallion [1993], Kocherlakota [1996], Kletzer and Wright [2000], and Ligon, Thomas and Worrall [2002]. All these studies define self-enforcing agreements as those that are proof from noncompliance by individual members of the group. According to the theory, the individual defector is isolated from the community, so that he must self-insure. With this insight in place, the common practice in the literature has been to define self-enforcing risk-sharing agreements as subgame perfect equilibria of a repeated game (in which self-insurance is always an option), and to characterize the Pareto frontier of such equilibria. Most studies focus on risk-sharing among identical agents. One exception is Genicot [2003] who investigates the effect of wealth inequality on these voluntary risk-sharing agreements. This paper considers risk-sharing between two agents whose resources, at any date, are composed of their share of a secure endowment, that we shall call their permanent income or wealth, and a random component. If it weren’t for their wealth, the two agents would be identical. Changes in the distribution of wealth do not affect the aggregate resources at any time, and therefore the Pareto set is unchanged. However, by changing their autarchic utilities, the wealth distribution affects the set of self-enforcing payoff vectors. Surprisingly, inequality is shown to help risk-sharing in a large range of cases. In this project, we plan on experimentally investigate the interaction between inequality and risk-sharing without commitment.
Sample Parameter File
View riskshare-sample.txt.
Download riskshare-sample.txt.
