"Moral Hazard in Risk Sharing? The Role of Social Ties"

Abstract: This paper examines whether social ties sustain informal insurance when there is asymmetric information over effort. I use a laboratory experiment, implemented with residents of slums in Nairobi, Kenya, that captures features of a model of risk sharing and effort provision. I find that individuals who do not know each other are 12.5% less likely to engage in risk sharing when effort cannot be observed. Socially close individuals engage in substantially higher levels of risk sharing when effort cannot be observed relative to socially distant pairs. Participants who know their partner make 57% higher transfers and are 55% more likely to engage in risk sharing than those who do not know their partner when effort cannot be observed. Thus, this paper provides evidence that social ties sustain cooperation when effort cannot be observed. Policies to protect households vulnerable to risk should target communities with weak social ties.

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