Essays on institutions in developing economies
Author(s)Wang, Xiao Yu, Ph. D. Massachusetts Institute of Technology
Massachusetts Institute of Technology. Department of Economics.
Abhijit V. Banerjee and Robert M. Townsend.
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The primary goal of this thesis is to gain a deeper understanding of how institutional structure responds and evolves in equilibrium, particularly in the idiosyncratic and dynamic settings of developing economies. I use methods from market design to study these questions. The first chapter characterizes the equilibrium response of informal insurance relationships to changes in the formal sector, when risk-averse agents may choose what risk to bear in addition to how to share a given risk. The second chapter studies informal insurance relationships in a setting with one-sided moral hazard, and shows how the tradeoff between incentive and insurance provision shapes the composition and nature of informal relationships. The third chapter focuses on a more general setting, where the standard price mechanism fails or is not available, and provides an explanation for why the stable mechanism used in its place works well in practice, despite appearing to be easily manipulable. In the first chapter, I develop a theory of endogenous matching between heterogeneously risk-averse individuals who, once matched, choose both the riskiness of the income stream they face (ex ante risk management) as well as how to share that risk (ex post risk management). I find a clean condition on the fundamentals of the model for unique positive-assortative and negative-assortative matching in risk attitudes. From this, I derive an intuitive falsifiability condition, discuss support for the theory in existing empirical work, and propose an experimental design to test the theory. Finally, I demonstrate the policy importance of understanding informal insurance as the risk-sharing achieved within the equilibrium network of partnerships, rather than within a single, isolated partnership. A hypothetical policy which red c aggregate risk is a strict Pareto improvement if the matching is unchanged, but can be se n to h the most risk-averse individuals and to exacerbate inequality when the endogenous network response is taken into account: the least risk-averse individuals abandon their "oles as informal insurers in favor of entrepreneurial partnerships. This results in an increase in the risk borne by the most risk-averse agents, who must now match with each other on low-return investments. The aim of my second chapter is to understand the impact of optimal provision of both risk and incentives on the choice of contracting partners. I study a risky setting where heterogeneously risk-averse employers and employees must match to be productive. They face a standard one-sided moral hazard problem: mean output increases in the noncontractible input of the employee. Better insurance comes at the cost of weaker incentives, and this tradeoff differs across partnerships of different risk compositions. I show that this heterogeneous tradeoff determines the equilibrium matching pattern, and focus on environments in which assortative matching is the unique equilibrium. This endogenous matching framework enables a concrete and rigorous analysis of the interaction between formal and informal insurance. In particular, I show that the introduction of formal insurance crowds out informal insurance, and may leave those individuals acting as informal insurers in the status quo strictly worse off. My third chapter is motivated by the observation that mechanisms which implement stable matchings often work well in practice, even in environments where individuals could gain by using simple strategies to game the mechanism. Why might individuals refrain from strategic manipulation, even when the complexity cost of manipulation is low? I study a two-sided, one-to-one matching problem with no side transfers, where utility is interdependent in the following intuitive sense: an individual's utility from a match depends not only on her preference ranking of her assigned partner, but also on that partner's ranking of her. I show that, in a world of complete information and linear interdependence, a unique stable matching emerges, and is attained by a modified Gale-Shapley deferred acceptance algorithm. As a result, a stable rule supports truthtelling as an equilibrium strategy. Hence, these results offer a new intuition for why stable matching mechanisms seem to work well in practice, despite their theoretic manipulability: individuals may value being liked.
Thesis (Ph. D.)--Massachusetts Institute of Technology, Dept. of Economics, 2013.Cataloged from PDF version of thesis.Includes bibliographical references (p. 139-145).
DepartmentMassachusetts Institute of Technology. Department of Economics.
Massachusetts Institute of Technology