This paper analyses the smoothing of asymmetric shocks to output for a sample of OECD countries. The research finds no evidence of large differences in the patterns of risk sharing for the 19 OECD countries, the EU-15 or euro-area countries, for the period 1970-1999. However, there were shown to be considerable differences between the euro-area and the successful monetary union of the USA: the euro-area showed a much lower insurance of asymmetric shocks than the US states. In the US federation, 75% of the asymmetric shocks to output were smoothed in the period 1964-1990. However, in the euro-area only 44% of such shocks were not passed onto consumption in the period 1970-1999. Until increasing economic integration in Europe does not lead to a substantial decrease in the incidence of idiosyncratic shocks, such shocks may impose non-negligible welfare costs.
Due to a large contribution from the public sector to risk sharing, especially to smooth out more persistent shocks, it does not seem likely that private capital markets can easily replace the government, in the near future, in providing a sufficient degree of risk sharing in the euro-area. Even if capital markets become as integrated in the euro-area as they were in the US federation in the period 1964-1990...
Over the past two decades, more than
half the population in rural Tanzania migrated within the
country, profoundly changing the nature of traditional
institutions such as informal risk sharing. Mass internal
migration has created geographically disperse networks, on
which the authors collected detailed panel data. By
quantifying how shocks and consumption co-vary across linked
households, they show how migrants unilaterally insure their
extended family members at home. This finding contradicts
risk-sharing models based on reciprocity, but is consistent
with assistance driven by social norms. Migrants sacrifice 3
to 7 percent of their very substantial consumption growth to
provide this insurance, which seems too trivial to have any
stifling effect on their growth through migration.
Voluntary annuity markets are, in most
countries, smaller than what the theoretical and part of the
empirical literature would suggest. There are both demand
and supply constraints that hamper the development of
annuity markets. In particular, traditional products
available in most countries can require excessive minimum
capital requirements for given investment opportunities
available to providers. Investment and longevity risk should
be shared between providers and annuitants so that supply
constraints can be relaxed. Alternative annuity products,
which imply risk sharing, could be backed by substantially
lower capital investments or, equivalently, provided at
substantially lower prices to consumers.
Empirical work in labor economics has
focused on rent sharing as an explanation for the observed
correlation between wages and profitability. The alternative
explanation of risk sharing between workers and employers
has not been tested. Using a unique panel data set for four
African countries, Authors find strong evidence of risk
sharing. Workers in effect offer insurance to employers:
when firms are hit by temporary shocks, the effect on
profits is cushioned by risk sharing with workers. Rent
sharing is a symptom of an inefficient labor market. Risk
sharing; by contrast, can be seen as an efficient response
to missing markets. Authors evidence suggests that risk
sharing accounts for a substantial part of the observed
effect of shocks on wages.
We investigate the dual role of money as a self-insurance device and a means of payment when perfect risk sharing is not possible, and when the two roles of money are disentangled. We use a variant of Lagos–Wright (2005) where agents face a risk in the centralized market (CM): in the decentralized market(DM) money’s main role is as a means of payment, while in the CM it is as a self-insurance device. We show that state-contingent inflation rates can improve agents’ ability to self-insure in the CM, thereby improving the terms of trade in the DM.We then characterize the optimal monetary policy.; Nicolas L. Jacquet and Serene Tan
Social Security and Risk Sharing
In this paper we identify conditions under which the introduction of a pay-as-you-go social security system is ex-ante Pareto-improving in a stochastic overlapping generations economy with capital accumulation and land. We argue that these conditions are consistent with many calibrations of the model used in the literature. In our model financial markets are complete and competitive equilibria are interim Pareto efficient. Therefore, a welfare improvement can only be obtained if agents.welfare is evaluated ex ante, and arises from the possibility of inducing, through social security, an improved level of intergenerational risk sharing. We will also examine the optimal size of a given social security system as well as its optimal reform. The analysis will be carried out in a relatively simple set-up, where the various effects of social security, on the prices of long-lived assets and the stock of capital, and hence on output, wages and risky rates of returns, can be clearly identified.
This paper studies the role of preference and income risk heterogeneity when risk sharing is partial due to limited commitment. I estimate the dynamic contract determining self-enforcing insurance transfers in a structural manner, and allow the coefficient of relative risk aversion and multiplicative income risk to differ across households. I find that the model explains the consumption allocation significantly better than the homogenous version and the benchmarks of perfect risk sharing and autarky, using household survey data from rural Pakistan. Enforcement constraints bind more often with heterogeneous households, implying less risk sharing. The paper then examines how social policies would interact with existing informal insurance arrangements. I simulate the effects of counterfactual transfers targeting the poor on consumption by both eligible and ineligible households. In the case of a one-time transfer, the heterogeneous (homogeneous) model predicts that consumption by ineligible households increases by one fifth (one fourth) of the transfer; if the transfer is permanent, the predicted share of ineligible households is one tenth (one fifth).
While it is recognized that the family is primarily an institution for risk sharing, little is known about the quantitative effects of this informal source of insurance on savings and labor supply. In this paper, we present a model where workers (females and males) are subject to idiosyncratic employment risk and where capital markets are incomplete. A household is formed by a female and a male, who make collective decisions on consumption, savings and labor supplies. In a calibrated version of our model, we find that precautionary savings are only 55% of those generated by a similar economy that lacks access to insurance from the family. We also find that intra-household risk sharing has its largest impact among wealthpoor households. While the wealth-rich use mainly savings to smooth consumption across unemployment spells, wealth-poor households rely on spousal labor supply. For instance, in the group of households with wealth less than two months worth of income, average hours worked by wives of unemployed husbands are 8% higher than those worked by wives of employed husbands. This response in wives’ hours makes up 9% of lost family income. We also find crowding out effects of public unemployment insurance that are comparable to those estimated from the data.
We decompose the Backus-Smith  statistic -- a low or negative correlation between relative consumption and the real exchange rate at odds with a high degree of international risk sharing -- in its dynamic components at different frequencies. Using multivariate spectral analysis techniques we show that, in most OECD countries, the dynamic correlation tends to be more negative, and significantly so, at business cycle or lower frequencies -- the appropriate frequencies for assessing the performance of international business cycle models. Theoretically, we show that the dynamic correlation predicted by standard open-economy models is the sum of two terms: a term constant across frequencies, which can be negative as a function of uninsurable risk; a term variable across frequencies, which in bond economies is necessarily positive, reflecting the insurance intertemporal trade provides against forecastable contingencies. We show that the main mechanisms proposed in the literature to account for the puzzle are consistent with the evidence.
The aim of this paper is to investigate how the capacity of an economic system to absorb shocks depends on the specific pattern of interconnections established among financial firms. The key trade-off at work is between the risk-sharing gains enjoyed by firms when they become more interconnected and the large-scale costs resulting from an increased risk exposure. We focus on two dimensions of the network structure: the size of the (disjoint) components into which the network is divided, and the "relative density" of connections within each component. We find that when the distribution of the shocks displays "fat" tails extreme segmentation is optimal, while minimal segmentation and high density are optimal when the distribution exhibits "thin" tails. For other, less regular distributions intermediate degrees of segmentation and sparser connections are also optimal. We also find that there is typically a conflict between efficiency and pairwise stability, due to a "size externality" that is not internalized by firms who belong to components that have reached an individually optimal size. Finally, optimality requires perfect assortativity for firms in a component.
We extend the model of risk sharing with limited commitment (Kocherlakota, 1996) by introducing both a public and a private (non-contractible and/or non-observable) storage technology. Positive public storage relaxes future participation constraints and may hence 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. In the long run, 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.
While it is recognized that the family is primarily an institution for risk sharing, little is known about the quantitative effects of this informal source of insurance on savings and labor supply. In this paper, we present a model where workers (females and males) are subject to idiosyncratic employment risk and where capital markets are incomplete. A household is formed by a female and a male, who make collective decisions on consumption, savings and labor supplies. We find that intra-household risk sharing has its largest impact among wealthpoor households. While the wealth-rich use mainly savings to smooth consumption across unemployment spells, wealth-poor households rely on spousal labor supply. For instance, for low-wealth households, average hours worked by wives of unemployed husbands are 8% higher than those worked by wives of employed husbands. This response in wives’ hours makes up 9% of lost family income. We also study the crowding out effects of public unemployment insurance on other sources of private insurance, and consumption losses upon an unemployment spell
This paper analyzes optimal monetary policy in a two-country model with asymmetric shocks. Agents insure against risk through the exchange of Arrow- Debreu securities. Although central banks commit to the policy that maximizes domestic welfare, this does not lead to price stability. In an attempt to improve their country’s terms of trade of securities, central banks may choose an inflationary policy rule in good states. If both central banks do so, the effects on the terms of trade wash out, leaving both countries worse off. Countries facing asymmetric shocks may therefore gain from monetary cooperation; Financial
support from the Cornmission for Cultural, Educational and Scientific Exchange between the United
States of America and Spain (Project 7-42) is gratefully acknowledged; This paper is part of a larger research program with Marco Celentani and J.
Ignacio Conde-Ruiz on the effects of fiscal and monetary policy on risk sharing
We analyze risk sharing and endogenous fiscal spending in a two-region model with sequentially complete markets. Fiscal policy is determined by majority voting. When policy setting is decentralized, regions choose fiscal spending in an attempt to manipulate security prices. This leads to incomplete risk sharing, despite the existence of complete markets and the absence of aggregate risk. When a fiscal union centralizes fiscal policy, complete risk sharing ensues. If regions are relatively homogeneous, median income residents of both regions prefer the fiscal union. If they are relatively heterogeneous, the median resident of the rich region prefers the decentralized setting.
We analyze risk sharing and fiscal spending in a two-region model with complete markets. Fiscal policy is determined by majority voting. When policy setting is decentralized, regions choose pro-cyclical fiscal spending in an attempt to manipulate securities prices to their benefit. This leads to incomplete risk sharing, despite the existence of complete markets and the absence of aggregate risk. When a fiscal union centralizes fiscal policy, securities prices can no longer be manipulated and complete risk sharing ensues. If regions are homogeneous, median income residents of both regions prefer the fiscal union. If they are heterogeneous, the median resident of the rich region prefers the decentralized setting; Marco Celentani acknowledges the financial support of MCYT (Spain) under project PB98-00024. José-Ignacio Conde-Ruiz acknowledges the financial support of MECD (Spain) under project EX200l-02885993E. Klaus Desmet acknowledges the financial support of the Commission for Cultural Educational and Scienlific Exchange between
the United States of America and Spain (Project 7-42) and the Comunidad de Madrid (Project 06/O064/2000).
The aim of this paper is to investigate how the capacity of an economic system to absorb shocks depends on the specific pattern of interconnections established among financial firms. The key trade-off at work is between the risk-sharing gains enjoyed by firms when they become more interconnected and the large-scale costs resulting from an increased risk exposure. We focus on two dimensions of the network structure: the size of the (disjoint) components into which the network is divided, and the “relative density" of connections within each component. We find that when the distribution of the shocks displays "fat" tails extreme segmentation is optimal, while minimal segmentation and high density are optimal when the distribution exhibits "thin" tails. For other, less regular distributions intermediate degrees of segmentation and sparser connections are also optimal. We also find that there is typically a conflict between efficiency and pairwise stability, due to a “size externality" that is not internalized by firms who belong to components that have reached an individually optimal size. Finally, optimality requires perfect assortativity for firms in a component.; We
acknowledge financial support for the EUI Research Council, and from the Spanish Ministry of the Economy
and Competitiveness under grants ECO2012-34581 and RESINEE.
Following Lucas's (1987) standard
approach, welfare gains from international risk-sharing have
been measured as the percentage increase in consumption
levels that leaves individuals indifferent between, autarky
and risk-sharing. The author proposes to measure welfare
gains as the increase in consumption growth, instead of
consumption levels. When the consumption process is
non-stationary, the author's proposed measure has
several attractive features: it does not depend on the
horizon, and it is robust to alternative specifications of
the consumption stochastic processes (from geometric
Brownian processes, to Orstein-Ulhenbeck mean-reverting
processes), and preferences (from constant relative risk
aversion preferences to Kreps-Porteus preferences). The
author then uses this measure to estimate potential welfare
gains from international risk-sharing for a representative
U.S. consumer. The author finds that if international
risk-sharing leads only to a complete elimination of
aggregate consumption volatility (with no impact on
A simple econometric analysis is
undertaken concerning the impact of the degree of risk
sharing in countries' health financing organization on
the goals of the health system, as defined in the World
Health Report 2000, i.e., the level of health and its
distribution across the population, the level of
responsiveness and its distribution across the population,
and fair financing. The degree of risk sharing varies
according to whether countries have a universal coverage
system, financed via social health insurance or general
taxation, or systems with less well-developed coverage
including variants of social health insurance and/or general
taxation benefiting specific population groups. The research
undertook a classification of countries according to the
degree of risk sharing, based primarily on the health care
financing legislation of the World Health
Organization's 191 member states and on its data base
of Health System Profiles. The results obtained give
empirical support to the hypothesis that the degree of risk
sharing in health financing organizations impacts positively
on health system attainment...
This paper evaluates the degree of
consumption insurance enjoyed by Latin American and
Caribbean countries, with respect to various reference
areas, by estimating a parameter expressing the sensitivity
of a country's consumption growth to a measure of
idiosyncratic shocks to income. The paper surveys common
econometric implementations of "consumption insurance
tests." The author proposes some econometric procedures
in order to detect the actual presence of international risk
sharing, as well as to assess the relative impact of
idiosyncratic versus aggregate shocks. The evidence suggests
that Latin American and Caribbean economies have been hit by
non-diversifiable income shocks, that idiosyncratic risk is
relatively more important than aggregate risk, and that some
countries in the region appear to enjoy a certain amount of
international risk diversification. The paper also
identifies some macroeconomic factors that may be
responsible for a higher or lower degree of risk pooling
(such as international openness...
We offer a new explanation of partial risk sharing based on coalition formation and segmentation of society in a risky environment, without assuming limited commitment and imperfect information. Heterogenous individuals in a society freely choose with whom they will share risk. A partition belonging to the core of the membership game obtains. Perfect risk sharing does not necessarily arise. Focusing on mutual insurance rule and assuming that individuals only differ with respect to risk, we show that the core partition is homophily-based. The distribution of risk affects the number and size of these coalitions. Individuals may pay a lower risk premium in riskier societies. A higher heterogeneity in risk leads to a lower degree of risk sharing. We discuss how the endogenous partition of society into risk-sharing coalitions may shed light on empirical evidence on partial risk sharing. The case of heterogenous risk aversion leads to similar results.