Robust Decisions for Heterogeneous Agents via Certainty Equivalents

Abstract

We study the problem of a planner who resolves risk-return trade-offs -like financial investment decisions -on behalf of a collective of agents with heterogeneous risk preferences. The planner's objective is a two-stage utility functional where an outer utility function is applied to the distribution of the agents' certainty equivalents from a given decision. Assuming lognormal risks and heterogeneous power utility preferences for the agents, we characterize optimal behavior in a setting where the planner can let each agent choose between different options from a fixed menu of possible decisions, leading to a grouping of the agents by risk preferences. These optimal decision menus are derived first for the case where the planner knows the distribution of preferences exactly and then for a case where he faces uncertainty about this distribution, only having access to upper and lower bounds on agents' relative risk aversion. Finally, we provide tight bounds on the welfare loss from offering a finite menu of choices rather than fully personalized decisions. * We thank Antje Mahayni, Peter Schotman, Hans Schumacher and participants at the Netspar International Pension Workshop 2021 for very helpful comments and discussions.