Efficient risk sharing with limited commitment and storage
Title: Efficient risk sharing with limited commitment and storage
Citation: Review of economic studies, 2018, Vol. 85, No. 3, pp. 1389-1424
ISSN: 0034-6527; 1467-937X
We extend the model of risk sharing with limited commitment by introducing both a public and a private (unobservable and/or non-contractible) storage technology. Positive public storage relaxes future participation constraints, hence it can improve risk sharing, contrary to the case where hidden income or effort is the deep friction. The characteristics of constrained-efficient allocations crucially depend on the storage technology's return. At the steady state, if the return on storage is (i) moderately high, both assets and the consumption distribution may remain time-varying (ii) sufficiently high, assets converge almost surely to a constant and the consumption distribution is time-invariant (iii) equal to agents' discount rate, perfect risk sharing is self-enforcing. Agents never have an incentive to use their private storage technology, i.e. Euler inequalities are always satisfied, at the constrained-efficient allocation of our model, while this is not the case without optimal public asset accumulation. Finally, we find that, in contrast with the limited-commitment model without storage, past income affects consumption growth negatively both in our model with storage and in data from Indian villages.
Subject: Risk sharing; Limited commitment; Hidden storage; Dynamic contracts; Intertemporal behavior; Village economies; Hidden savings; Repeated games; Insurance; Contracts; Allocations; Investment; Decisions; Income
Published: 31 October 2017
Grant number: FP7/612796/EU
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