DP14333 Coalition-Proof Risk Sharing Under Frictions

Author(s): Harold Cole, Dirk Krueger, George J Mailath, Yena Park
Publication Date: January 2020
Keyword(s): Coalitions, Limited Commitment, Risk Sharing
JEL(s): E20
Programme Areas: Public Economics, International Macroeconomics and Finance, Monetary Economics and Fluctuations, Macroeconomics and Growth
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14333

We analyze efficient risk-sharing arrangements when coalitions may deviate. Coalitions form to insure against idiosyncratic income risk. Self-enforcing contracts for both the original coalition and any deviating coalition rely on a belief in future cooperation, and we treat the contracting conditions of original and deviating coalitions symmetrically. We show that better belief coordination (higher social capital) tightens incentive constraints since it facilitates both the formation of the original as well as a deviating coalition. As a consequence, the payoff of successfully formed coalitions might be declining in the degree of belief coordination and equilibrium allocations might feature resource burning or utility burning.