Risk sharing and quasi-credit

Abstract

Recent empirical evidence indicates that rural households in the Third World smooth consumption through reciprocal gifts and informal credit but fail to achieve Pareto efficiency in risk sharing. Extending previous models of informal contracts as repeated games, this paper shows that several often-described features of informal risk sharing arrangements can be understood as limitations imposed by their self-enforcing nature. We argue that informal credit between friends and relatives is a hybrid transaction, halfway between market exchange and gift giving, whose purpose is to overcome enforcement problems present in pure income pooling arrangements.