Risk-Sharing and Endogenous Network Formation

Abstract

In economic literature insurance networks are often treated as exogenous institutions. Frequently, the assumption is made that some clearly identifiable group (e.g. 'the whole village' or 'the extended family') constitutes an insurance network. Still, theory suggests that the formation of insurance links depends on a myriad of factors related to smooth information flows, norms, trust, the ability to punish, discount rates, group size and the potential gains of cooperation (e.g. how correlated income streams are and the amount of other income smoothing strategies available). Recent research has shown that risk is more likely to be shared in small, tightly knit networks, which do not necessarily coincide with a collection of households delineated on the basis of just one factor like kinship or place of residence. However, so far only few empirical attempts have been made at investigating the determinants of network formation. This paper suggests an approach by which one might present stylized facts on endogenous network formation. Applying it to a data set collected in a Haya village in rural Tanzania, we find that kinship, geographical proximity, the number of common friends, clan membership, religious affiliation and wealth strongly determine the formation of risk-sharing networks. Our data suggest that poor households have less dense networks than the rich, making them more vulnerable in the face of idiosyncratic risk.

Networks and Economic Behavior

“…There are many other such settings, that I will not detail here, but just to mention a few, they include studies of risk-sharing among networks of individuals (e.g., Fafchamps and Lund (2004), De Weerdt (2004), De Weerdt and Dercon (2006, Bloch, Genicot and Ray (2005), and Bramoullé and Kranton (2005) ); networks of research and development, patent, and other joint ventures among firms (see the survey by Bloch (2004)); as well as more every-day activities such as how smoking and obesity are affected by friends' behaviors (e.g., Fowler (2007, 2008)). …”

International Risk Sharing and Globalization

“…A first strand of the literature has been investigating the effects of the documented 1 increase in financial integration on international risk sharing; another, more recent strand is exploring (theoretically and empirically) the role of social networks among individuals (and households) on consumption insurance (e.g. Fafchamps and Lund (2003);De Weerdt (2004); Bramoullé and Kranton (2007); Ambrus et al (2010); Fafchamps (2011); Bloch et al (2008)). We will focus on the first strand, but before reviewing the most influential contributions might be helpful to stress two things.…”

Risk and Reciprocity Over the Mobile Phone Network: Evidence from Rwanda

“…In much of East Africa, for instance, formal money transfer systems such as Western Union are only available in major urban areas, and informal methods (such as sending money with a public bus driver) are slow, intermittent, and expensive. Thus, the empirical evidence indicates that in-kind and monetary transfers typically occur between friends and family within small, local communities (Udry 1994, De Weerdt & Research 2002, Fafchamps & Gubert 2007.…”