Efficient Risk Sharing with Limited Commitment and Storage

Abstract

We extend the model of risk sharing with limited commitment (Kocherlakota, 1996) by introducing both a public and a private (unobservable and/or non-contractible) storage technology. Positive public storage relaxes future participation constraints, hence it can 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. We compare the dynamics of consumption in simulated data and data from Indian villages, and find that past incomes matter in a similar way in our model with storage and the data but not in the basic limited-commitment model.

Dynamic relational contracts under complete information

“…Ábrahám and Lacsó (2018) establish a similar result in a model of risk-sharing model and storage. The absence of the amnesia property is more consistent with the empirical evidence (seeBroer, 2013).…”

“…Third, there are a very few papers in this limited commitment literature that examine the situation where two or more agents take actions. The most relevant paper to ours is Acemoglu et al (2011) that considers a model of changes in political power. In Acemoglu et al (2011) a Markov process determines which risk-averse political party is in power.…”

“…The most relevant paper to ours is Acemoglu et al (2011) that considers a model of changes in political power. In Acemoglu et al (2011) a Markov process determines which risk-averse political party is in power. Political parties take actions that contribute to a common pool of resources whether in power or not, but only the party in power gets to determine the allocation of resources across agents.…”

Temporary Migration and Endogenous Risk Sharing in Village India

“…5 For papers that extend limited commitment to include asset accumulation, see for example Ligon et al (2000); Kehoe and Perri (2002); Krueger and Perri (2006); Abraham and Laczo (2014). 6 For studies examining migration with intra-household incentive constraints, see Chen (2006); Gemici (2011); Dustmann and Mestres (2010).…”

Recursive Contracts

“… Among others, Marcet and Marimon () studied one‐sided constraints in a small open economy, Broer () characterized the stationary distribution of consumption, Ábrahám and Laczó () characterized analytically the solution. …”