Reciprocity without commitment

Abstract

Various risk sharing arrangements are common in underdeveloped agrarian economies where households have no formal means of contract enforcement and little access to risk markets. Social insurance is still possible through repeated interaction in an environment with few informational asymmetries. In a simple repeated game model of two self-interested households facing independent income streams, we characterize the best arrangement that can be sustained as a noncooperative equilibrium. We establish precisely how this optimal informal arrangement differs from first best-risk sharing, and identify the conditions under which the divergence between the two is greatest.