Brendan Daley from Johns Hopkins University will present "Risk Sharing and Strategic Choice"
Informal risk-sharing agreements offer an avenue to improve economic welfare via both a more efficient allocation of risks (Wilson, 1968) and increased incentives to undertake more productive (though risky) endeavors. Prominent examples include risk sharing between farmers in developing economies (Townsend, 1994) and between individual members of a household (Mazzocco, 2004). We employ a decision-theoretic approach to the analysis of these choices. We provide behavioral foundations (i.e., axioms) for a model of informal risk sharing and show that the sharing arrangement can be identified from observable choices of risky endeavors. A key observation is that such arrangements generate incentives to be opportunistic in the individual choice of risky endeavor, as this determines the individual's disagreement value and therefore can strengthen her bargaining position in the negotiation of the sharing agreement. We then utilize the model to investigate the behavioral implications of prominent bargaining solutions in the literature, consider the effect of frictions, and investigate the equilibrium loss in efficiency from individually rational opportunistic behavior.