Working Paper: CEPR ID: DP14333
Authors: Harold L. Cole; Dirk Krueger; George J. Mailath; Yena Park
Abstract: We analyze efficient risk-sharing arrangements when the value from deviating is determined endogenously by another risk sharing arrangement. Coalitions form to insure against idiosyncratic income risk. Self-enforcing contracts for both the original coalition and any coalition formed (joined) after deviations rely on a belief in future cooperation which we term ``trust''. We treat the contracting conditions of original and deviation coalitions symmetrically and show that higher trust tightens incentive constraints since it facilitates the formation of deviating coalitions. As a consequence, although trust facilitates the initial formation of coalitions, the extent of risk sharing in successfully formed coalitions is declining in the extent of trust and efficient allocations might feature resource burning or utility burning: trust is indeed a double-edged sword.
Keywords: coalitions; risk sharing; limited commitment
JEL Codes: E20; E21; G22; D11; D91
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| trust (G21) | coalition formation (C71) |
| trust (G21) | risk-sharing efficacy (D63) |
| coalition formation (C71) | risk-sharing efficacy (D63) |