Investments in Social Ties, Risk Sharing and Inequality

This paper investigates stable and efficient networks in the context of risk-sharing, when it is costly to establish and maintain relationships that facilitate risk-sharing. We find a novel trade-off between efficiency and equality. The most stable efficient networks also generate the most inequality. The result extends to correlated income structures with individuals split into groups, such that incomes across groups are less correlated but these relationships are more costly. We find that more central agents have better incentives to form across-group links, reaffirming the efficiency benefits of having highly central agents and thus the efficiency inequality trade-off. Our results are robust to many extensions. In general, endogenously formed networks in the risk sharing context tend to exhibit highly asymmetric structures, and stark inequalities in consumption levels.