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Risk allocation and financial intermediation

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  • Goussebaïle, Arnaud

Abstract

The classic Arrow–Debreu framework requires a very large number of specific securities to reach Pareto optimality. The present paper shows that financial intermediation can play an important role in maintaining a more parsimonious market framework while still obtaining Pareto optimality. In the framework developed, the aggregate risk components of individual risks are exchanged through a highly reduced set of nonspecific securities, while the idiosyncratic risk components are insured through financial intermediation. Reaching Pareto optimality does not rest on a Law of Large Numbers approximation. The role of financial intermediation is complementary to the role of security derivatives and dynamic trading.

Suggested Citation

  • Goussebaïle, Arnaud, 2022. "Risk allocation and financial intermediation," Mathematical Social Sciences, Elsevier, vol. 120(C), pages 78-84.
    • Handle: RePEc:eee:matsoc:v:120:y:2022:i:c:p:78-84
    DOI: 10.1016/j.mathsocsci.2022.09.004
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