Consumption risk-sharing in social networks

Abstract: We develop a model of informal risk-sharing in social networks, where relationships between individuals can be used as social collateral to enforce insurance payments. We characterize incentive compatible risk-sharing arrangements and obtain two results. (1) The degree of informal insurance is governed by the expansiveness of the network, measured by the number of connections that groups of agents have with the rest of the community, relative to group size. Two-dimensional networks, where people have connections in multiple directions, are sufficiently expansive to allow very good risk-sharing. Social networks in Peruvian villages are shown to satisfy this condition, suggesting that real-world village networks should generate good informal insurance. (2) In second-best arrangements, agents organize in endogenous "risk-sharing islands" in the network, where shocks are shared fully within, but imperfectly across islands. As a result, network based risk-sharing is local: socially closer agents insure each other more. These results can be used to study the spillover effects of development aid.
This is joint work with Markus Mobius and Adam Szeidl.


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Attila Ambrus