Informal Risk Sharing under Risk Heterogeneity

Informal risk sharing enables individuals to smooth consumption when access to formal insurance is limited. While previous studies have examined the roles of income correlation and initial income inequality, little is known about how differences in individual risk exposure affect voluntary risk sharing. We investigate this question using a laboratory experiment based on an indefinitely repeated risk-sharing game. Subjects are randomly assigned to either homogeneous income risk, in which both members of a pair face the same level of risk, or heterogeneous income risk, in which one subject faces high income risk and the other faces low income risk. The benchmark repeated-game model predicts that transfers should be highest under homogeneous high income risk and lower, but comparable, under homogeneous low income risk and heterogeneous income risk. Consistent with this prediction, transfers are higher when both subjects face high income risk than when both face low income risk. However, subjects facing heterogeneous income risk exhibit a higher incidence of positive transfers than those in the homogeneous-risk configurations. Although average transfers under heterogeneous income risk lie between those observed under homogeneous high and homogeneous low income risk, they are considerably closer to the former than the latter. These findings provide the first experimental evidence that heterogeneous income risk does not undermine voluntary risk sharing and may instead encourage greater participation in reciprocal transfer arrangements.