Risk-sharing Implications Research Articles

Altruism and Risk Sharing in Networks

Abstract We provide the first analysis of the risk-sharing implications of altruism networks. Agents are embedded in a fixed network and care about each other. We explore whether altruistic transfers help smooth consumption and how this depends on the shape of the network. We find that altruism networks have a first-order impact on risk. Altruistic transfers generate efficient insurance when the network of perfect altruistic ties is strongly connected. We uncover two specific empirical implications of altruism networks. First, bridges can generate good overall risk sharing, and, more generally, the quality of informal insurance depends on the average path length of the network. Second, large shocks are well-insured by connected altruism networks. By contrast, large shocks tend to be badly insured in models of informal insurance with frictions. We characterize what happens for shocks that leave the structure of giving relationships unchanged. We further explore the relationship between consumption variance and centrality, correlation in consumption streams across agents, and the impact of adding links.

Estimating Non-stationary Common Factors: Implications for Risk Sharing

In this paper, we analyze and compare the finite sample properties of alternative factor extraction procedures in the context of non-stationary Dynamic Factor Models (DFMs). On top of considering procedures already available in the literature, we extend the hybrid method based on the combination of principal components and Kalman filter and smoothing algorithms to non-stationary models. We show that if the idiosyncratic noises are stationary, procedures based on extracting the factors using the non-stationary original series work better than those based on differenced variables. We apply the methodology to the analysis of cross-border risk sharing by fitting non-stationary DFM to aggregate Gross Domestic Product and consumption of a set of 21 industrialized countries from the Organization for Economic Co-operation and Development (OECD). The goal is to check if international risk sharing is a short- or long-run issue.

Bundling and Unbundling in Public–Private Partnerships: Implications for Risk Sharing in Urban Transport Projects

Public–private partnership (PPP) projects may be organized in a variety of ways, depending on the level of integration of the so-called Special Purpose Vehicle. Based on the analyses of four major PPP light rail projects in Spain, this article outlines two fundamentally different models of organizing the Special Purpose Vehicle in PPP projects; moreover, the article examines the central principles of these two different models of organizing the private sector Special Purpose Vehicle and their implications for risk sharing and project management in large-scale infrastructure PPP projects.

Risk-Sharing Implications for Roth IRA Conversions: Fact and Fiction

We investigate the risk-sharing implications of taxation associated with the option to convert a traditional IRA to Roth IRA. Although the conversion option may create value for savers by potentially reducing their tax burdens, the risk profile of their holdings may change. Delaying payment of the conversion tax creates a leveraged equity position for the taxpayer. We show that the conversion decision depends on the dynamics of the underlying asset, including volatility and its path through time. Moreover, how asset dynamics affect the ultimate payoff depends on the financing source for the conversion tax payment. These factors render some conventional wisdom around conversion unreliable.

Incentives and Nutrition for Rotten Kids: Intrahousehold Food Allocation in the Philippines

Using data on individual consumption expenditures from a sample of farm households in the Philippines, we construct a direct test of the risk-sharing implications of the collective house-hold model. We are able to contrast the efficient outcomes predicted by the collective household model with the outcomes we might expect in environments in which food consumption delivers not only utils, but also nutrients which affect future productivity. Finally, we are able to contrast each of these two models with a third, involving a hidden action problem within the household; in this case, the efficient provision of incentives implies that the consumption of each household member depends on their (stochastic) productivity.The efficiency conditions which characterize the within-household allocation of food under the collective household model are violated, as consumption shares respond to earnings shocks. If future productivity depends on current nutrition, then this can explain some but not all of the response, as it appears that the quality of current consumption depends on past earnings. This suggests that some actions taken by household members are private, giving rise to a moral hazard problem within the household.

MONETARY POLICY AND ENDOWMENT RISK IN A LIMITED PARTICIPATION MODEL

I. INTRODUCTION An asset market segmentation model is constructed in this paper to study the risk-sharing role of monetary policy. Economic agents face uninsurable endowment risk when there is limited asset market participation. Because an initial money injection goes first to those who can access the asset market, money is nonneutral and monetary policy redistributes consumption across agents. Thus, monetary policy plays a risk-sharing role that provides crude insurance. Limited participation models that capture nonneutralities of money were initially developed by Grossman and Weiss (1983) and Rotemberg (1984) and followed by Lucas (1990), Fuerst (1992), and Chatterjee and Corbae (1992). Recently, Alvarez and Atkeson (1997), Alvarez, Lucas, and Weber (2001), and Alvarez, Atkeson, and Kehoe (2002) have made important contributions, but they focus on the implications of liquidity effects, asset prices, and the exchange rate instead of the risk-sharing implications of monetary policy. My model is built on Alvarez, Lucas, and Weber (2001). There are two types of households: traders who participate in the asset market and nontraders who do not. These types are determined exogenously. In each period, traders receive constant endowments, whereas nontraders face uninsurable endowment shocks. In the asset market, the government injects money through open market operations and traders initially receive the money injection. In equilibrium, money is nonneutral and monetary policy redistributes consumption between traders and nontraders. The government money injection increases traders' consumption and decreases nontraders' consumption because traders get the money injection through the asset market whereas nontraders suffer from inflation. If nontraders all receive the same endowment shock, then monetary policy is a perfect risk-sharing tool that can smooth out consumption across traders and nontraders. However, if nontraders receive idiosyncratic endowment shocks, then monetary policy is not enough to perfectly insure nontraders. Although monetary policy does not achieve a Pareto optimal allocation, it can mitigate the dispersion of consumption across nontraders. The optimal money growth rate can be positive or negative depending on the endowment distribution. The Friedman rule is not optimal in general. There is a set of limited participation literature where the asset market is endogenously segmented: Chatterjee and Corbae (1992), Alavarez, Atkeson, and Kehoe (2002), Chiu (2004), and Chiu and Molico (2007). Although endogenous asset market segmentation is useful in some contexts, for this paper nothing is lost by assuming exogenous segmentation, and much is gained in simplicity. Models of the redistributional effects of monetary policy include Levine (1991), Shi (1999), Berentsen, Camera, and Waller (2005), and Molico (2006). The models studied by Levine (1991) and Mollico (2006) are particularly relevant. Levine (1991) studies an incomplete markets environment where positive money growth implemented through lump-sum transfers can be optimal. Molico (2006) studies a search environment and shows, similarly, that positive inflation with lump-sum transfers can be welfare-enhancing, but not at high rates of inflation. In both the Levine (1991) and Molico (2006) environments, there is an insurance role for monetary policy, much as in the environment studied in this paper. The model here has the virtue of being much more tractable than either the Levine (1991) or Molico (2006) models. Furthermore, a novelty here is to study an insurance role for monetary policy in the context of market segmentation, where the agents who received the first-round effects of monetary policy do not wish to share risk among themselves. The key risk-sharing problem has to do with risk sharing between asset market participants and nonparticipants. The remainder of the paper is organized as follows. …

Intergenerational risk sharing and fiscal policy

Risk-sharing implications of alternative fiscal policies are compared in a stochastic production economy with overlapping generations. Ex ante efficiency is shown to be achievable with optimal transfers, regardless of distributional concerns. For CRRA preferences, stylized real-world policies (notably safe debt and safe pensions) are found inefficient in the direction of imposing not enough productivity risk on retirees and too much on future generations. Safe transfers can be rationalized as efficient if preferences display age-increasing risk aversion, such as habit formation. The ubiquity of safe transfers suggests that governments treat the young as more risk tolerant than older cohorts.

Investing Public Pensions in the Stock Market: Implications for Risk Sharing, Capital Formation and Public Policy in the Developed and Developing World

Concerns that existing public pension systems will be unable to pay benefits to a rapidly ageing population without sharp tax increases, and the prospect of higher average returns on stocks than on government securities, are drawing the attention of policy–makers worldwide to the option of investing public pension assets in stocks. Including stock market investments in public pension plans could improve risk sharing within and between generations, and could perhaps lead to faster market development in some countries. It could also result in excessive risk–taking, higher transactions costs and a false sense of increased financial security. This paper assesses these issues, with an emphasis on the considerations that are of special importance to developing markets. A contrast is drawn between the demographic outlook in East Asia and the major industrialized countries. Some lessons are drawn from the reform experience in Chile and elsewhere in Latin America.

The role of risk in contract choice

Structuring contracts to share risk in light of incentive problems is the central premise of contract theory, yet the risk-sharing implications have rarely been thoroughly tested using micro-level contract data. In this article we test the major implications of a principal-agent model of contracts using detailed data on more than 4000 individual contracts from modern North American agriculture. On a case-by-case basis, our evidence fails to support the standard principal-agent model with risk aversion as an explanation of contract choice in modern North American farming. At the same time, we find some support for models that assume risk-neutral contracting parties and stress multiple margins for moral hazard and enforcement costs.

The risk-sharing implications of alternative social security arrangements

An important aspect of the current U.S. social security system is the tradeoff between the risk-sharing it provides and the distortions it imparts on private decisions. We focus on this tradeoff as it applies to labor market risk and capital accumulation. Specifically, we compare the current U.S. system to a particular proposal put forth in 1996 by the federal Advisory Council on Social Security (1996). We also examine the merits of abolishing social security altogether. We find that, absent general equilibrium effects, the risk-sharing benefits of the current system outweigh the distortions associated with either the alternative or a system of privately administered pensions. Once we incorporate equilibrium effects, however, the interaction between the social security system, private-savings decisions, and the means with which the government finances its nonpension expenditures results in a significant welfare benefit being associated with either reform or abolition. These welfare gains arise in spite of the fact that we explicitly incorporate the ‘social security debt’: the social cost of meeting the obligations associated with the current system.

The risk-sharing implications of alternative social security arrangements: A comment

The risk-sharing implications of alternative social security arrangements: A comment

Multinational Investment Attraction: Principal-Agent Considerations

Government agencies are becoming increasingly involved in the process of providing investment supports to attract foreign direct investment (FDI).This paper focuses on the problem of how best to structure the investment supports. Five different types of investment supports are theoretically and empirically analysed. In each case the effect of the principal-agent relationships between the MNE investor and the agency charged with attracting FDI are assessed in the strategic context. Theoretical analysis suggests that in some cases, governments may prefer support schemes that appear to be more expensive, but have better incentive or risk-sharing implications. Empirical analysis suggests that MNE firm characteristics are related to the type of investment support package obtained.

Rediscounting under aggregate risk

This paper compares three institutions that offer an elastic currency – open market operations, a discount window, and a private, banknote-issuing clearinghouse – in an economy with financial markets otherwise hampered by a lack of liquidity. When this economy is subject to aggregate financial shocks, these alternative forms of central banking are shown to differ in their implications for risk-sharing. Interesting implications include (i) central bank losses and monetary innovations that are part of an efficient equilibrium; and (ii) desirable quantity restrictions at the discount window.