Capital-Allocation-Induced Risk Sharing

TL;DR

This paper introduces a novel class of risk-sharing rules derived from randomized capital allocation principles, linking capital distribution within firms to risk sharing among participants.

Contribution

It proposes a new approach to risk sharing by randomizing existing capital allocation rules, extending theoretical frameworks beyond traditional economic and Pareto optimality principles.

Findings

Derives new risk-sharing rules from randomized capital allocations.

Extends existing literature with novel risk-sharing frameworks.

Provides theoretical insights into risk distribution mechanisms.

Abstract

This article proposes a new class of risk-sharing rules by exploring the relationship between capital allocation and risk sharing. While the former is concerned with ex-ante allocating capitals to different lines of business within a corporation based on the relationship among the individual risks, often also through the aggregate risk, the latter is an arrangement which collects risks from and allocates them to, also ex-ante, a group of participants. Drawing on this analogy, we introduce a novel idea of inducing risk-sharing rules by randomizing existing capital allocation principles. Such an approach derives new risk-sharing rules complementing known results in the literature, which were largely based on economic principles and Pareto optimality.