Faculty of Economics and Business Administration Publications Database

Implications of Endogenous Group Formation for Efficient Risk-Sharing

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Volume: 119
Number: 536
Pages: 562 - 591
Month: March
ISSN-Print: 0013-0133
Link External Source: Online Version
Year: 2009
Abstract: The existing literature on sub-game perfect risk-sharing suffers from a basic inconsistency. While a group of size n is able to coordinate on a risk-sharing outcome, it is assumed that deviating subgroups cannot. I relax this assumption and characterise the optimal contract among all coalition-proof history-dependent contracts. This alters the predictions of the standard dynamic limited commitment model. I show that the consumption of constrained agents depends on both the history of shocks and its interaction with the current income of other constrained agents. From this, I derive a formal test for the presence of endogenous group formation under limited commitment.
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