Risk Sharing

7 Key excerpts on "Risk Sharing"

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  eBook - PDF

  Macroeconomic Policy and Islamic Finance in Malaysia

  • Azura Othman, Norhanim Mat Sari, Syed Othman Alhabshi, Abbas Mirakhor(Authors)
  • 2017(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  In a broader context, Risk Sharing involves a “contractual or societal arrangement whereby the outcome of a random event is borne collectively by a group of individuals or entities involved in a contract, or by individuals or entities in a community” (Askari et al. 2012). Risk Sharing requires “skin-in-the-game” (Taleb 2012) where all participants 2 RISK TRANSFER, Risk Sharing, AND ISLAMIC FINANCE 31 are entitled to returns that are contingent on the outcome. Under this arrangement, the upside potential (profit) and the downside risk (loss) are shared ex post. As opposed to risk transfer where return to inves- tor is guaranteed, Risk Sharing involves taking monetary risks, which may or may not result in the desirable return. No risk is to be shifted or transferred, and any liability must always be tagged to the right to profit (Mirakhor 2014). Risk Sharing, on the other hand, means the lender will participate in the risk of the venture undertaken by the borrower. Both parties will share in the risk and rewards of the venture. One important inference of the risk-sharing concept is that it can become a powerful tool to reduce the uncertainty of future ventures, yet without reducing the undertaking of risk itself. Risk Sharing could help consumption smoothing to address the idiosyncratic risk of individuals. A more detailed explanation of the concept of Risk Sharing will be given in Chap. 4. THE ROLE OF DEBT IN FINANCIAL CRISES At the core of a conventional economic system is the interest-based financial system with banks being the main institution that operates the financial system. The traditional function of a bank is to accept depos- its from the surplus sector of the economy and channel it to the def- icit sector in the form of lending. This financial intermediation has an important function in the economy in that it facilitates the circulation of surplus wealth for productive use within the economy.

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  Wealth Inequality, Asset Redistribution and Risk-Sharing Islamic Finance

  • Tarik Akin, Abbas Mirakhor(Authors)
  • 2019(Publication Date)
  • De Gruyter Oldenbourg

    (Publisher)

  28

  The Arrow-Debreu-Hahn general equilibrium models, which are discussed in Chapter 3.5.3, are the risk-sharing conceptualizations in which contingent claims are shared concomitant to the risk bearing ability of the economic agents. Hence, risk-sharing contracts have the advantage of working through and within market forces and not against them (Bacha and Mirakhor 2013 , 270). Moreover, Mirakhor and Bao (2013 , 54) highlight that

  equity share claims represent first-best instruments of Risk Sharing and satisfy characteristics required of Arrow Securities. It would appear that had the financial markets in industrial countries developed their financial sector along the lines suggested by the Arrow-Debreu-Hahn model, they could have had much more efficient Risk Sharing, and perhaps avoided the crises that have plagued the conventional financial system.

  Within the context of economics of inequality, the risk-sharing mechanisms provide shared prosperity through several channels. Maybe the most important contribution of the risk-sharing mechanisms is its role in mitigating the pro-cyclicality in financial system. This contribution is pertinently related to the inequality-financial crises nexus explained in the previous section. In theory, one of the main roles of the financial system is to mitigate shocks emanating from fluctuations in economic cycle. In effect, such a system produces counter-cyclicality between the financial and economic cycles. However, the reverse (pro-cyclicality) is the norm and intrinsic to the financial system mostly due to the co-movements between economic activity and credit growth, as well as, liquidity and expectation shocks to the banking system (Rochet 2008 , 96). As underlined by Mian (2013 , sec. 2) the fundamental driver of financial recessions is a failure of risk-sharing. He also argues that the workhorse macroeconomic models assume that households can shield themselves against asset price shocks, this is proven false in the real-world data, though (Mian 2013 , 1). Against the debt-based system, risk-sharing system render the financial system counter-cycle due to its inherent nature that the returns depend on contingent realizations (Askari et al. 2010

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  Ethical Dimensions of Islamic Finance

  Theory and Practice

  • Zamir Iqbal, Abbas Mirakhor(Authors)
  • 2017(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  In doing so, it can minimize monitoring, super- visory, and disciplinary costs leading to efficiency gains. As a result, participants in a contract of an economic undertaking can choose higher risk–higher return projects and thus increase the efficiency and produc- tivity of the system. Risk Sharing finance provides two powerful addi- tional sources of economic expansion and growth. First, through sharing contracts, micro and small enterprises that are normally credit- constrained can expand their operations or engage in innovative activi- ties that otherwise would not be undertaken. Asset-poor participants become less risk-averse, allowing them to seek higher risk–higher reward ventures. Second, households can hedge against idiosyncratic 34 See, Samuel Bowles 2012. The New Economics of Inequality and Redistribution. New York: Cambridge University Press; see also, Michael Lewis and Pat Conaty 2012. The Resilience Imperative: Cooperative Transition to a Steady-State Economy. Gabriola Island, Canada: New Society Publishers. 6.5 CONCLUSION 158 risk by becoming asset holders or shareholders, instead of depositors, and hence diversify their sources of income by investing in productive activities. This increases investment in projects that are typically rationed out of the market due to lack of collateral, no track record, no credit his- tory, and a host of other adverse selection factors. Risk Sharing can also create a reciprocal and trusting environment that strengthens social cohe- sion, promotes social mobility, and reduces income inequality without perverse incentive effects and resentments that would lead to resistance to changes in the status quo that marks income-based redistribution efforts and without creating a conflict with proposals to improvement in the state of “being” in a society (Rosanvallon 2013; Sen 1992).

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  Public Finance and Islamic Capital Markets

  Theory and Application

  • Syed Aun R. Rizvi, Obiyathulla I. Bacha, Abbas Mirakhor(Authors)
  • 2016(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  b ). Globalization was expected to improve international and domestic Risk Sharing. Empirical research has demonstrated a sizeable failure in this regard. Governments have enormous potential for intervention to promote Risk Sharing, as they are the ultimate risk managers of their societies. Their power to tax, spend and enforce gives them not only the necessary clout but also the ability to make credible commitments on behalf of their societies as their agent. They can use this capacity to issue securities that allow households and firms to mitigate their idiosyncratic risks against which they are not insured. These instruments can also allow countries to share their risks by expanding opportunities for international Risk Sharing. What has become disappointingly clear is that, even in the richest societies, public policy-generated means of protecting people against the risk of shocks, over which they have no control but which affect their livelihood significantly, have been woefully inadequate. Macromarket securities can provide significant opportunities to individuals, households, firms and countries to mitigate the adverse consequences of shocks through diversification.

  The foundation of Islamic finance, in other words Risk Sharing, presents an alternative to the present interest rate-based debt-financing regime that has brought individual and global economies to the verge of collapse. In this chapter we continue the earlier discussions in the Review on Islamic Finance (Askari and Krichene 2014 ; Askari et al. 2014 ) to extend the idea of Risk Sharing to fiscal and monetary policies. It argues that through Risk Sharing instruments, governments can reduce the fiscal burden, expand fiscal space and strengthen governance through involvement of citizens in directly financing development expenditure. The proposal is worth considering by economies under a heavy debt burden, including European countries (Mirakhor 2011a ).

  The core principle of Islamic finance is Risk Sharing. As a young industry it has not managed to develop truly Risk Sharing instruments that would allow individuals, households and firms, as well as whole economies, to mitigate systematic and unsystematic risks. Nor is there any sense of direction that could compel an expectation that such developments are on the horizon. We suggest that governments could issue macromarket instruments that could provide them with a significant source of non- interest rate-based financing while promoting Risk Sharing, provided that these securities meet three conditions: (1) they are low in denomination; (2) sold on the retail market; and (3) have a strong governance/oversight structure. Moreover, given the growing evidence across the world that the mechanism of monetary policy may be impaired, it is suggested that these government-issued securities could impart significant potency to monetary policy. Finally, we should also consider the present problem facing Europe and the global economy. Much of the debate has been focused on ‘haircuts’ for the private sector banks and bail-out resources from the European Central Bank and the countries of Western Europe. As many have noted, this will only “kick the can down the road” and add more debt on top of a mountain of debt that already exists. Could macromarket instruments such as those discussed in this paper help mitigate the risk of sovereign default threatening the global economy? Consider the possibility of a macromarket instrument that could be issued jointly by the IMF, with additional resources provided by some members of the G20, with its rate of return tied to the growth of global GDP. This could give immediate relief to the countries at risk of sovereign default, allow the economies of these countries fiscal and growth space and remove the threat to the global banking and financial system.

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  Protecting All

  Risk Sharing for a Diverse and Diversifying World of Work

  • Truman Packard, Ugo Gentilini, Margaret Grosh, Philip O'Keefe, Robert Palacios, David Robalino, Indhira Santos(Authors)
  • 2019(Publication Date)
  • World Bank

    (Publisher)

  The Conceptual Underpinnings of Risk-Sharing Policy | 85 minimum support. In the three remaining segments of the stylized package of protection, responsibility for financing and provision shifts gradually away from purely public resources and direct government provision to household or individual financing and market provision. The specific contents of this package are developed in greater detail in later chapters. Notes 1. Based on Barr (2012), Ehrlich and Becker (1972, 1992), and Gill and Ilahi (2000). A fuller presentation of our conceptual framework, underpinned by economic and actuarial principles, is provided in appendix A. 2. See, for example, Dreze and Sen (1989) for an early and seminal discussion of social policy objectives. For an extension of a risk management framework to include assets, see Jørgensen and Siegel (2019). 3. For a discussion of the indirect jobs and general equilibrium effects, see Robalino, Romero, and Walker (2017). 4. For more information on this effect, see the Tunisia Systematic Country Diagnostic (World Bank 2015). 5. For more information on this effect, see Merotto (2017). 6. The World Development Report 2013: Jobs (World Bank 2012) points to some of the sources of social externalities related to jobs: (i) women who have a job invest more in the human capital of their children; (ii) youth who have a job learn on the job and make other workers in society more productive; and (iii) jobs can contribute to peace and social stability. 7. Investments in new technologies and products can push the technological frontier forward and facilitate future innovation. They also can increase firms’ absorptive capacity (their ability to assimilate knowledge from their environ-ment) and therefore help firms identify further opportunities for investment and job creation (Aghion and Jaravel 2015). 8. Coordination failures emerge when economic agents are unable to achieve coordination among complementary activities.

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  Handbook of Social Economics SET: 1A, 1B

  • Jess Benhabib, Alberto Bisin, Matthew O. Jackson(Authors)
  • 2010(Publication Date)
  • North Holland

    (Publisher)

  Idiosyncratic risk generates potential gains from trade: risk averse individuals subject to independent sources of risk can increase their welfare by pooling risk. Many of the social welfare institutions that exist in developed economies today began some hundred years ago as mutual insurance societies against illness, death or unemployment. For covariate risk, mutual gains from trade arise whenever economic agents differ in their degree of risk aversion. In this case it is common for a risk neutral agent – e.g., a rich individual or a corporation – to insure risk averse individuals subject to common shocks.

  Risk Sharing between households can in principle be achieved through contracts enforceable by courts. This applies for instance to insurance contracts, joint liability contracts, and corporations, among others. Court enforcement is not always feasible, however. Courts may be absent or unreliable, or the arrangement may be unverifiable, illegal, or simply unprotected by law. Because of the contingent nature of mutual insurance arrangements, writing a complete contract allowing for all contingencies may be too time consuming or simply impossible. Furthermore, many transactions are too small to justify court action, or the parties too poor to recover anything in case of victory in court. This is particularly true in developing countries where many firms and market transactions are small and many people are too poor to be sued.

  In these circumstances the legal enforcement of Risk Sharing contracts is problematic even though the mutual gains may be large. Informal enforcement mechanisms become necessary. The literature has explored several mechanisms by which Risk Sharing between households can be sustained without reliance on the court system. Detailed discussions are provided in Platteau (1994a) , Platteau (1994b) , Fafchamps (1992) , and Cox and Fafchamps (2007) .

  One possibility is to rely on preferences and emotions, either directly in the form of altruism, or indirectly via social norms that are punished through guilt and shame. Another possibility is to rely on long-term strategic interaction among self-interested individuals. The first avenue has been explored in detail by psychologists, sociologists, and anthropologists, but has also received significant attention from economists. The second was initially put forth by anthropologists and sociologists and subsequently formalized by economists. In this section we present an overview of this literature, beginning with the repeated interaction approach.

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  Migrants and Markets

  Perspectives from Economics and the Other Social Sciences

  • Holger Kolb, Henrik Egbert, Holger Kolb, Henrik Egbert(Authors)
  • 2008(Publication Date)
  • Amsterdam University Press

    (Publisher)

  Workers’ Remittances and International Risk Sharing 1 Metodij Hadzi-Vaskov 1 Introduction The process of international financial integration, which accelerated in the past two decades, can potentially bring numerous benefits to the world economy. One of the central benefits it offers to the residents of different countries is the possibility to diversify their macroeconomic risks internationally. Therefore, through the process of cross-border trade in assets, these countries can relax the link between domestic output growth and domestic consumption (income) growth up to the point when the latter will depend exclusively on the world output growth. 2 This process, through which country-specific risks are diversi-fied away across national borders, is known as international risk shar-ing. Moreover, the finance literature usually associates it with the un-derlying trade in financial assets. Therefore, investment in an interna-tionally diversified portfolio is identified as the major channel through which the process of international Risk Sharing takes place. Similarly, the deviation from the hypothesis of perfect or complete Risk Sharing is associated with the tendency by investors to over-invest in domestic as-sets and thereby forego many diversification opportunities available through investment in foreign assets. This latter phenomenon is also known in the finance literature as home equity (or bond) bias. Since the bias in investment strategies seems to be the most obvious reason for the deviation from complete Risk Sharing, many empirical studies investigate the relationship between the two. Though the association between the two phenomena is very clear for the group of advanced economies, it might not be as important for the developing world. Therefore, this paper concentrates on an alternative channel through which one country can smooth consumption and di-versify its idiosyncratic risks internationally.

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