Risk Sharing Capacity: Markets versus Households

Abstract

We introduce uncertainty in our general equilibrium model with multi-member groups, following the classical state-space approach of Arrow-Debreu. A host of new interesting economic issues emerge. First, risk averse agents can attempt to insure themselves through markets or through mutual insurance within a multi-member group, say a household, by pooling resources within the group. Which insurance mechanism is chosen and to which extent the mechanisms substitute or complement each other is an open question. Second, one may ask more specifically what is the role of social groups for risk sharing and risk allocation when agents face idiosyncratic or aggregate risk. Third, does a suitable combination of social group formation and contingent commodity markets yield efficient risk allocations? We present a series of examples that shed some light on these issues.