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

  • 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)

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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File URL: http://www.kier.kyoto-u.ac.jp/DP/DP621.pdf
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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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  1. Chiaki Hara, 2005. "Heterogeneous Risk Attitudes in a Continuous-Time Model," KIER Working Papers 609, Kyoto University, Institute of Economic Research.
  2. Miles S. Kimball, 1989. "Precautionary Saving in the Small and in the Large," NBER Working Papers 2848, National Bureau of Economic Research, Inc.
  3. 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.
  4. David K. Levine & William R. Zame, 2002. "Does Market Incompleteness Matter?," Econometrica, Econometric Society, vol. 70(5), pages 1805-1839, September.
  5. Hara, Chiaki & Huang, James & Kuzmics, Christoph, 2007. "Representative consumer's risk aversion and efficient risk-sharing rules," Journal of Economic Theory, Elsevier, vol. 137(1), pages 652-672, November.
  6. Felix Kubler & Karl Schmedders, 2000. "Incomplete Markets, Transitory Shocks and Welfare," Levine's Working Paper Archive 2133, David K. Levine.
  7. repec:knz:cofedp:0305 is not listed on IDEAS
  8. Leland, Hayne E, 1980. " Who Should Buy Portfolio Insurance?," Journal of Finance, American Finance Association, vol. 35(2), pages 581-94, May.
  9. 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.
  10. 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.
  11. 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.
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