Risk Sharing Externalities / Luigi Bocola, Guido Lorenzoni.

Format:

Book

Author/Creator:

Bocola, Luigi.

Contributor:

National Bureau of Economic Research.

Lorenzoni, Guido.

Series:

Working Paper Series (National Bureau of Economic Research) no. w26985.

NBER working paper series no. w26985

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2020.

Summary:

Financial crises typically arise because firms and financial institutions choose balance sheets that expose them to aggregate risk. We propose a theory to explain these risk exposures. We study a financial accelerator model where entrepreneurs can issue state-contingent claims to consumers. Even though entrepreneurs could use these contingent claims to hedge negative shocks, we show that they tend not to do so. This is because it is costly to buy insurance against these shocks as consumers are also harmed by them. This effect is self-reinforcing, as the fact that entrepreneurs are unhedged amplifies the negative effects of shocks on consumers' incomes. We show that this feedback can be quantitatively important and lead to inefficiently high risk exposure for entrepreneurs.

Notes:

Print version record

April 2020.