Heterogeneity of Preferences, Limited Commitment and.pdf

Heterogeneity of Preferences, Limited Commitment and Coalitions: Empirical Evidence on the Limits to Risk Sharing in Rural Pakistan Pierre Dubois∗ This Version: August 2005† Abstract In this paper, we study the determinants of the value of informal risk sharing groups. In particular, we look at the effects of heterogeneity of preferences and of limited commitment constraints that restrict feasible allocations differently if individuals can deviate form risk sharing agreements in coalitions or not. We test empirically several predictable implications in rural Pakistan taking into account the het- erogeneity of households’ preferences. Our results show that exogenous size of risk sharing groups can be rejected or that only imperfect risk sharing is obtained within the village because of limited commitment and because of the risk of coalition formation that needs to be deterred. Key words: risk, insurance, risk aversion, limited commitment, coalitions, Pakistan. ∗University of Toulouse (INRA, IDEI) and CEPR Manufacture des Tabacs 21 allée de Brienne 31000 Toulouse France dubois@toulouse.inra.fr †I am grateful to Chris Barrett, Yann Bramoullé, Marcel Fafchamps, Andrew Foster, Thierry Magnac, Kaivan Munshi and Debraj Ray for useful discussions and participants at the workshop on Social Dynamics and the Microeconomics of Poverty in Bellagio. A previous version circulated under the title Coalition-Proof Informal Insurance and Endogenous Association Cost. I am the sole responsible for remaining errors. 1 1 Introduction Economic theory tells that with uncertainty and under complete markets, Pareto efficiency requires