Trust in Risk Sharing: A Double-Edged Sword

Abstract We analyse efficient risk-sharing arrangements when the value from deviating is determined endogenously by another arrangement. Coalitions form to insure against idiosyncratic income risk. Self-enforcing contracts for both original coalition and any formed (joined) after deviations rely on a belief in future cooperation which we term “trust”. treat contracting conditions of deviation coalitions symmetrically show that higher trust tightens incentive constraints since it facilitates formation coalitions. As consequence, although initial coalitions, extent risk sharing successfully declining allocations might feature resource burning or utility burning: indeed double-edged sword.