Abstract
This paper studies the extent to which poor institutions compromise risk-sharing. We model a multilateral organization as a social contract that provides insurance to members. Countries privately observe the realization of a performance variable with a verification cost that differs across countries, reflecting the “transparency” of institutions. When the level of transparency is exogenous, the optimal contract provides complete expected risk sharing across countries and states. Poor transparency and enforcement reduce consumption and result in insurance rationing. When a country can increase transparency endogenously, this generates an externality and moral hazard. We first characterize the outcome when the multilateral agency can influence members’ institutions by choosing the countries’ level of effort. Next we derive a tax/subsidy scheme that can induce countries to choose the socially optimal level.
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JEL Classification Numbers D8, F3
We are grateful to Biung-Ghi Ju, Ted Juhl, Donald Lien, Joseph Sicilian and Jianbo Zhang for helpful comments. We are especially grateful to an anonymous referee for comments that improved the paper substantially.
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Asiedu, E., Jin, Y. & Villamil, A.P. Do lack of transparency and enforcement undermine international risk-sharing?. Annals of Finance 2, 123–140 (2006). https://doi.org/10.1007/s10436-005-0032-9
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DOI: https://doi.org/10.1007/s10436-005-0032-9