Does Savings Crowd Out Informal Insurance? Evidence from a Lab Experiment in the Field

Arun Chandrasekhar
Cynthia Kinnan
Horacio Larreguy
Publication Type: 
Working Papers
Publication Year: 
2010

We use a laboratory experiment, conducted in 34 villages in Karnataka, India, to study the interaction between inability to commit to remain in an insurance agreement and ability to save income over time. We study the welfare consequences of access to savings when interpersonal insurance is constrained by limited commitment. These consequences are theoretically ambiguous: savings access allows smoothing of uninsured risk but also makes leaving the insurance agreement more palatable, which may affect consumption smoothing by reducing inter-household transfers. We also examine the effect on transfers and consumption smoothing of imposing a grim trigger post-defection strategy (permanent reversion to autarky). We conduct games in which individuals face risky payoffs and can smooth this income risk by sharing with a randomly-assigned partner and, sometimes, by saving. In one treatment, we exogenously impose the grim trigger strategy. In the other treatment, we allow individuals to endogenously choose a response to defection by playing a sequential dictator game (SDG). When players are committed by the experimental design to use the grim trigger strategy, defection is rare and limited commitment does not appear to bind significantly. However, when players are free to choose a response to defection, defection rates are high and players punish each other significantly less than imposed by grim trigger. We use social network data to compute the social distance between pairs, and show that limited commitment constraints significantly limit insurance when risk-sharing partners are socially distant, but not when pairs are closely connected. For distant pairs, access to savings helps to smooth income risk that is not insured interpersonally.

JEL Codes: 
C91, D85, O16
Region: 
South and Central Asia
Country: 
India
Topic: 
Economic Modeling
Topic: 
Experiments
Topic: 
Insurance
Topic: 
Savings
Topic: 
Risk
Topic: 
Networks
Topic: 
Consumption
Topic: 
Randomized Evaluation