In developing societies, in the absence of formal insurance markets, when a household faces a catastrophic financial shock, are they left completely on their own? In this Independent Study thesis, I argue that these households have an informal insurance arrangement amongst themselves in which "current generosity is justified by future reciprocity" (Coate & Ravallion, 1993). Assuming that the income endowments of the households follow a memoryless stochastic Markov process, I argue that a risky environment where a financial catastrophe is always around the corner for any household makes these households continue to participate in this income-sharing arrangement. Developing a model of informal insurance using Markov chains and running a numerical simulation, I show that the stability of such an arrangement dependent only on the extent to which the present generation values the future alongside their degree of risk aversion and the severity of a possible catastrophe.
Mitra, Sayantan, "Holding Hands Against the Unknown: Using Markov Chains to Model Informal Insurance Arrangements in Developing Societies" (2016). Senior Independent Study Theses. Paper 7134.
Economic Theory | Other Applied Mathematics
Bachelor of Arts
Senior Independent Study Thesis
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