Coalition-Proof Risk Sharing Under Frictions
We analyze efficient risk-sharing arrangements when coalitions may deviate. Coalitions form to insure against idiosyncratic income risk. Self-enforcing contracts for both the original coalition and any deviating coalition rely on a belief in future cooperation, and we treat the contracting conditions of original and deviating coalitions symmetrically. We show that better belief coordination (higher social capital) tightens incentive constraints since it facilitates both the formation of the original as well as a deviating coalition. As a consequence, the payoff of successfully formed coalitions might be declining in the degree of belief coordination and equilibrium allocations might feature resource burning or utility burning.
Cole, Krueger, and Mailath thank the National Science Foundation for research support (grants SES-112354, 1260753, 1326781, 1559369, 1757084, 1851449). The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.