The Limits to Local Insurance

Abstract

This paper characterizes feasible insurance arrangements when each agent’s risk can only be shared among a personalized subset of agents. We show that risk exposure in the resulting network is constrained (i.e. markets are not complete) unless at least one agent is connected to everyone else. We show that an individual’s ability to share even her own neighbors’ risks is constrained unless her neighborhood is a subset of someone else’s neighborhood. Moreover, we characterize which surrounding risks she can diversify: the joint shocks of any group of neighbors that have an additional neighbor in common. We show that most individuals in a real village network lack enough connections to diversify the majority of the joint shocks in their neighborhood.