ONLINE - Efficient Risk Sharing and Separation

25.11.2020 14:15 – 15:30

INSTITUTE OF ECONOMICS AND ECONOMETRICS SEMINAR / ABSTRACT

This paper extends the model of risk sharing with limited commitment Kocherlakota (REStud, 1996) to feature endogenous separation. Partners face idiosyncratic income and match quality shocks, share risk subject to limited commitment, and endogenously separate whenever they are better off doing so. We characterize analytically the sets of shock realizations when constrained-efficient separations occur and the dynamics of consumption while the risk-sharing partnership continues. Contrary to the basic model, consumption inequality can optimally exceed income inequality given any history of income shock realizations. We also study the determinants of the separation probability and show that the separation probability typically has a jump as parameter values change, due to complementarity between current and future risk sharing. When unobservable match quality shocks are persistent, the consumption sharing rule has predictive power for future separations, as it provides information about the underlying shocks. Our extension provides insights in several economic contexts where the basic model has been applied and separations do occur in practice. Examples include risk sharing between spouses, business partners, and countries in an economic union.

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