Distinguishing Barriers to Insurance in Thai Villages
A large body of evidence shows that informal insurance is an important risk-smoothing mechanism in developing countries but that this risk sharing is incomplete. Models of limited commitment, moral hazard, and hidden income have been proposed to explain the incomplete nature of informal insurance. Using the first-order conditions characterizing optimal insurance subject to each type of constraint, I show that the way history matters in forecasting consumption can be used to distinguish hidden income from limited commitment and moral hazard. This implication does not rely on a particular specification of the production technology or utility function. In a seven-year panel from rural Thailand, I show that neither limited commitment nor moral hazard can fully explain the relationship between income and consumption. In contrast, the predictions of the hidden income model are supported by the data.