Optimal risk sharing, equilibria, and welfare with empirically realistic risk attitudes

TL;DR

This paper investigates optimal risk sharing considering realistic risk attitudes, including risk seeking behaviors, and introduces new theoretical tools to analyze equilibria and welfare in such contexts.

Contribution

It extends risk sharing theory to include empirically observed risk seeking behaviors and generalizes expected utility, providing new foundational results and tools.

Findings

Risk seeking observed in empirical studies for certain subdomains.

Established Pareto optimality and equilibrium conditions with risk seeking agents.

Introduced a counter-monotonic improvement theorem as a new analytical tool.

Abstract

This paper examines optimal risk sharing for empirically realistic risk attitudes, providing results on Pareto optimality, competitive equilibria, utility frontiers, and the first and second theorems of welfare. Contrary to common theoretical assumptions, empirical studies find prevailing risk seeking in particular subdomains, in particular for losses. We first allow for some risk-seeking agents, still assuming expected utility. Yet more empirical realism is obtained by allowing agents to be neither risk averse nor risk seeking and by generalizing expected utility. Here we provide first results, pleading for future research. Our main new tool is a counter-monotonic improvement theorem.