Income Interdependence and Informal Risk Sharing: The Effects of Future Interactions and Directed Altruism

We propose a framework to analyze the effects of income correlation between two players on risk sharing without commitment. In theory, the likelihood that a risk-sharing agreement is self-enforcing decreases with income correlation. We tested this prediction in the laboratory with negative, zero, and positive correlation coefficients and observed the largest average transfer in the positive-correlation treatment. This surprising result suggests that experiencing the same state of income could create a social bond and induce altruism between the two players. Therefore, informal risk sharing can be successful in a group with social identity despite high income interdependence.