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Review of Economic Studies Vol. 91 No. 3 2024

Trust in Risk Sharing: A Double-Edged Sword

Harold L. Cole1; Dirk Krueger2; George J. Mailath3; Yena Park4

1 Department of Economics, University of Pennsylvania; NBER · 2 Department of Economics, University of Pennsylvania; NBER; CEPR · 3 Department of Economics, University of Pennsylvania; Research School of Economics, Australian National University · 4 Department of Economics, Seoul National University

Abstract

We analyse 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.

DOI
10.1093/restud/rdad071
Volume
91
Issue
3
Pages
1448-1497
Language
en
Sources
bibtex:phds-export.bib openalex crossref

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