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Efficient Risk-Sharing Rules with Heterogeneous Risk Attitudes and Background Risks

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Author Info

  • Chiaki Hara

    ()
    (Institute of Economic Research, Kyoto University)

  • James Huang

    ()
    (Department of Accounting and Management, Lancaster University Management School)

  • Christoph Kuzmics

    ()
    (MEDS, Kellogg School of Management, Northwestern University)

Abstract

In an exchange economy in which there is a complete set of markets for macroeconomic risks but no market for idiosyncratic risks, we consider how the efficient risk-sharing rules for the macroeconomic risk are affected by the heterogeneity in the consumers' risk attitudes and idiosyncratic risks. We provide sufficient conditions under which an idiosyncratic risk increases cautiousness (the derivative of the reciprocal of the absolute risk aversion), the determinant of the curvatures of the efficient risk-sharing rules. While the curvature of the risk-sharing rules at high consumption levels are governed by the consumers' risk attitudes, the curvature at low consumption levels depend not only on the risk attitudes but also on the lower tail distributions of the idiosyncratic risks.

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Bibliographic Info

Paper provided by Kyoto University, Institute of Economic Research in its series KIER Working Papers with number 621.

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Length: 30pages
Date of creation: May 2006
Date of revision:
Handle: RePEc:kyo:wpaper:621

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Keywords: Efficient risk-sharing rules; relative risk aversion; absolute risk tolerance; Inada condition; idiosyncratic risks; background risks; incomplete markets.;

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References

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  1. David K. Levine & William Zame, 2001. "Does Market Incompleteness Matter," Levine's Working Paper Archive 78, David K. Levine.
  2. Chiaki Hara, 2005. "Heterogeneous Risk Attitudes in a Continuous-Time Model," KIER Working Papers 609, Kyoto University, Institute of Economic Research.
  3. Günter Franke & Harris Schlesinger & Richard C. Stapleton, 2006. "Multiplicative Background Risk," Management Science, INFORMS, vol. 52(1), pages 146-153, January.
  4. Weil, Philippe, 1992. "Equilibrium asset prices with undiversifiable labor income risk," Journal of Economic Dynamics and Control, Elsevier, vol. 16(3-4), pages 769-790.
  5. Brennan, M.J. & Solanki, R., 1981. "Optimal Portfolio Insurance," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 16(03), pages 279-300, September.
  6. Hara, C. & Christoph Kuzmics, 2004. "Representative Consumer's Risk Aversion and Efficient Risk-Sharing Rules," Cambridge Working Papers in Economics 0452, Faculty of Economics, University of Cambridge.
  7. Hayne E. Leland., 1979. "Who Should Buy Portfolio Insurance?," Research Program in Finance Working Papers 95, University of California at Berkeley.
  8. Kimball, Miles S, 1990. "Precautionary Saving in the Small and in the Large," Econometrica, Econometric Society, vol. 58(1), pages 53-73, January.
  9. Felix Kubler & Karl Schmedders, 2001. "Incomplete Markets, Transitory Shocks, and Welfare," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 4(4), pages 747-766, October.
  10. Gollier, Christian & Pratt, John W, 1996. "Risk Vulnerability and the Tempering Effect of Background Risk," Econometrica, Econometric Society, vol. 64(5), pages 1109-23, September.
  11. Franke, Gunter & Stapleton, Richard C. & Subrahmanyam, Marti G., 1998. "Who Buys and Who Sells Options: The Role of Options in an Economy with Background Risk," Journal of Economic Theory, Elsevier, vol. 82(1), pages 89-109, September.
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Citations

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Cited by:
  1. Chiaki Hara, 2006. "Heterogeneous Risk Attitudes In A Continuous-Time Model," The Japanese Economic Review, Japanese Economic Association, vol. 57(3), pages 377-405.
  2. Maurizio Mazzocco & Shiv Saini, 2012. "Testing Efficient Risk Sharing with Heterogeneous Risk Preferences," American Economic Review, American Economic Association, vol. 102(1), pages 428-68, February.

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