Risk Sharing With Private and Public Information

According to the conventional view on efficient risk sharing (Hirshleifer, 1971), better information on future idiosyncratic income realizations harms risk sharing by evaporating insurance opportunities ex-ante. In our model, risk-averse agents receive public and private signals on future income realizations and engage in insurance contracts with limited enforceability. When considered separately, better public and private signals are detrimental to welfare. In contrast to the conventional view, we show that when private information is
sufficiently precise, more informative public signals can improve the allocation of risk. First, more informative public signals increase the riskiness of the consumption allocation, deteriorating risk sharing. Second, however, more informative public signals mitigate the welfare costs of private information and improve risk sharing. When private signals are sufficiently precise, the positive effect of better public information dominates the negative effect. The positive effect of public information can be quantitatively important in international risk
sharing.