Sharing ambiguous risks

Abstract

We analyse risk-sharing when individuals perceive ambiguity about future events. The main departure from previous work is that di¤erent individuals perceive ambiguity di¤erently. We show that individuals fail to share risks for extreme events. This may provide an explanation why we do not observe individuals buying insurance for certain events like hurricanes or earthquakes and why many contracts contain an "act of God" clause, which allows non-performance if an unforeseen event occurs.

Probability weighting and insurance demand in a unified framework

“…Schmidt (1999) characterizes efficient risk sharing under the dual theory with a concave probability weighting function. Chateauneuf et al (2000), Tsanakas and Christofides (2006), Chakravarty and Kelsey (2015), and Carlier and Dana (2008) go beyond the dual theory but focus on convex probability weighting functions. Xia and Zhou (2016) require all individuals in the economy to have the same probability weighting function.…”