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.