Participation in Risk-Sharing under Ambiguity

Jan Werner (University of Minnesota)
Thursday, December 15, 2011 - 4:15pm
Rudower Chaussee 25, Room 1.115

Expected utility hypothesis together with (strict) risk aversion and common probability beliefs among multiple agents have strong implications on patterns of efficient risk sharing. First, agents' consumption plans are comonotone with the aggregate resources. Second, every agent participates in risk sharing by holding at least a small fraction of the aggregate risk. These results are at odds with empirical observations. Ambiguity of beliefs has been suggested as a way to reconcile the differences between the observed patterns of risk sharing and the rules of efficient risk sharing. In this paper we focus on (non) participation in risk sharing. Ambiguity of beliefs is described by the multiple-prior expected utility model of Gilboa and Schmeidler (1989). The question we ask is whether and how can multiple-prior expected utility give rise to some agents not participating in efficient risk sharing. The main result says that if the aggregate risk is relatively small, then the agents whose beliefs are the most ambiguous will not participate in risk sharing. The higher the ambiguity of those agents' beliefs, the more likely is their non-participation. Another factor making the non-participation more likely is low risk aversion of agents whose beliefs are less ambiguous.