Testing Efficient Risk Sharing with Heterogeneous Risk Preferences: Semi-parametric Tests with an Application to Village Economies

Abstract

Previous tests of efficient risk sharing have assumed that households have identical risk preferences. This assumption is equivalent to the restriction that households can pool their resources, but cannot optimally allocate them according to individual risk preferences. In this paper, we first test the hypothesis of homogeneous risk preferences and reject it. This result implies that previous tests should have rejected efficiency even if households are perfectly sharing risk. We then derive two tests of efficient risk sharing that allow for heterogeneity in risk preferences. Using the two tests we cannot reject efficient risk sharingRisk Sharing, Efficiency, Heterogeneous Risk Preferences