Abstract:

We propose to replace the common notion of ‘village’ risk sharing by insurance in endogenous risk sharing groups. We model risk-sharing in a quantitative environment with  limited commitment where the requirement that contracts be ‘renegotiation-proof’, or immune to deviations by subcoalitions, makes group size endogenous. Apart from predicting a realistic degree of insurance, the model captures the evidence along two new dimensions: endogenously small insurance groups and symmetric consumption responses to income rises and falls. This is important, for example, because the crowding out effect of income insurance policies in this environment is substantially smaler than with a standard limited commitment constraint, and operates almost entirely through changes in the equilibrium size of insurance groups.