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A Generic Model for Public Provision of Insurance in the Presence of Externalities

Emerging markets are subject to exogenous shocks that are more frequent and bigger in size compared to the developed countries. Structural weaknesses such as currency mismatches in their balance sheets make these shocks even costlier. Yet, often times these countries are found having insufficient coverage against such shocks. Using a general equilibrium framework this paper looks at alternative government policies to encourage adequate provision of insurance when private decisions are not optimum socially. It also studies the impact of such policies on growth performance of the economy. A tax cum transfer scheme is found to be more effective in encouraging private provision of insurance compared to direct supply of hedging against shocks by the government. The optimal tax rate in our model depends on the extent to which decentralized level of insurance is socially sub-optimal.