“Federations, coalitions, and risk diversification”

[…] while we recognize that issues of participation in a coalition involve complex factors, there has been little discussion in the literature from a risk-sharing perspective. It is well-known in financial economics that the pooling of resources and the spreading of risk allows investors to realize a rate of return that approaches the expected rate. We take this to be a natural motive for federation formation among a group of regions. Indeed, the existence of an ancient state in China (the example given in the next section) supports our intuition. It appears that floods, droughts and the ability of a centralized authority to diversify risk paved the way for the unification of China as early as 2000 years ago. Thus, our approach is not empirically irrelevant.

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