Risk Sorting, Portfolio Choice, and Endogenous Informal Insurance / Xiao Yu Wang.

Format:

Book

Author/Creator:

Wang, Xiao Yu.

Contributor:

National Bureau of Economic Research.

Series:

Working Paper Series (National Bureau of Economic Research) no. w20429.

NBER working paper series no. w20429

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2014.

Summary:

Heterogeneously risk-averse individuals who lack access to formal insurance build and use relationships with each other to manage risk. I study the formation of these relationships. I show that the composition of equilibrium groups under pairwise matching and when group size is endogenous is determined by a trade-off in expected return and variance of return (captured by the coefficient of variation) across differentially risky productive opportunities, even when output distributions are skewed and have infinitely-many nonzero cumulants. This has important policy implications. For example, a policy which ignores the equilibrium response of informal institutions may exacerbate inequality and hurt most those it intended to help: a reduction in aggregate risk may lead to an increase in risk borne by the most risk-averse individuals, as the least risk-averse abandon their roles as informal insurers. Understanding informal occupations as equilibrium choices as opposed to exogenous assignments generates insights into the role played by endogenous insurance relationships in shaping informal firm structure and the development of entrepreneurship.

Notes:

Print version record

August 2014.