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The Diversification Theorem Restated: Risk-pooling Without Assignment of Probabilities

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  • Göran Skogh

    ()

  • Hong Wu

    ()

Abstract

Bayesian decision theory assumes that agents making choices assign subjective probabilities to outcomes, even in cases where information on probabilities is obviously absent. Here we show that agents that presume that they are equal risks can share risks mutually beneficially, even if the probabilities of losses are unpredictable or genuinely uncertain. We show also that different risk aversions among pool members do not exclude mutually beneficial loss sharing at uncertainty. Sharing when individuals’ losses differ in probabilities or in amount may still make individuals better off. Our findings are related to the theory of the insurance firm, to the management of development risks, and to the theory of justice. Copyright Springer Science + Business Media, Inc. 2005

Suggested Citation

  • Göran Skogh & Hong Wu, 2005. "The Diversification Theorem Restated: Risk-pooling Without Assignment of Probabilities," Journal of Risk and Uncertainty, Springer, vol. 31(1), pages 35-51, July.
  • Handle: RePEc:kap:jrisku:v:31:y:2005:i:1:p:35-51
    DOI: 10.1007/s11166-005-2929-0
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    File URL: http://hdl.handle.net/10.1007/s11166-005-2929-0
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    References listed on IDEAS

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    1. Goeran Skogh, 1999. "Risk-Sharing Institutions for Unpredictable Losses," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 155(3), pages 505-505, September.
    2. Rothschild, Michael & Stiglitz, Joseph E., 1971. "Increasing risk II: Its economic consequences," Journal of Economic Theory, Elsevier, vol. 3(1), pages 66-84, March.
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    Cited by:

    1. repec:pal:gpprii:v:42:y:2017:i:2:d:10.1057_s41288-016-0004-5 is not listed on IDEAS
    2. repec:pal:gpprii:v:42:y:2017:i:2:d:10.1057_s41288-016-0001-8 is not listed on IDEAS
    3. Lundtofte, Frederik, 2015. "Banks’ pooling of corporate debt: An application of the restated diversification theorem," The North American Journal of Economics and Finance, Elsevier, vol. 31(C), pages 249-263.
    4. Payandeh Najafabadi, Amir T. & Bazaz, Ali Panahi, 2016. "An optimal co-reinsurance strategy," Insurance: Mathematics and Economics, Elsevier, vol. 69(C), pages 149-155.

    More about this item

    Keywords

    risk; uncertainty; pooling; decision-making; justice;

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