Econometrica

Journal Of The Econometric Society

An International Society for the Advancement of Economic
Theory in its Relation to Statistics and Mathematics

Edited by: Guido W. Imbens • Print ISSN: 0012-9682 • Online ISSN: 1468-0262

Econometrica: Jul, 2008, Volume 76, Issue 4

Formal and Informal Risk Sharing in LDCs: Theory and Empirical Evidence

https://doi.org/10.1111/j.1468-0262.2008.00857.x
p. 679-725

Pierre Dubois, Bruno Jullien, Thierry Magnac

We develop and estimate a model of dynamic interactions in which commitment is limited and contracts are incomplete to explain the patterns of income and consumption growth in village economies of less developed countries. Households can insure each other through both formal contracts and informal agreements, that is, self‐enforcing agreements specifying voluntary transfers. This theoretical setting nests the case of complete markets and the case where only informal agreements are available. We derive a system of nonlinear equations for income and consumption growth. A key prediction of our model is that both variables are affected by lagged consumption as a consequence of the interplay of formal and informal contracting possibilities. In a semiparametric setting, we prove identification, derive testable restrictions, and estimate the model with the use of data from Pakistani villages. Empirical results are consistent with the economic arguments. Incentive constraints due to self‐enforcement bind with positive probability and formal contracts are used to reduce this probability.


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Supplemental Material

Supplement to "Formal and Informal Risk Sharing in LDCs: Theory and Empirical Evidence"

This zip file contains a PDF file describing data and all necessary variables used to be able to replicate results.

Supplement to "Formal and Informal Risk Sharing in LDCs: Theory and Empirical Evidence"

This zip file contains a PDF file describing data and all necessary variables used to be able to replicate results.