Trust in Risk Sharing: A Double-Edged Sword
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.
-
-
Copy CitationHarold L. Cole, Dirk Krueger, George J. Mailath, and Yena Park, "Trust in Risk Sharing: A Double-Edged Sword," NBER Working Paper 26667 (2020), https://doi.org/10.3386/w26667.Download Citation
-
Published Versions
Harold L Cole & Dirk Krueger & George J Mailath & Yena Park, 2024. "Trust in Risk Sharing: A Double-Edged Sword," Review of Economic Studies, vol 91(3), pages 1448-1497.
Related
More from the NBER
In addition to working papers, the NBER disseminates affiliates’ latest findings through a range of free periodicals — the NBER Reporter, the NBER Digest, the Bulletin on Health, and the Bulletin on Entrepreneurship — as well as online conference reports, video lectures, and interviews.
