Optimal risk sharing, equilibria, and welfare with empirically realistic risk attitudes

Paper: arXiv 2401.03328

Authors: Jean-Gabriel Lauzier, Liyuan Lin, Peter Wakker, Ruodu Wang

Abstract

This paper examines optimal risk sharing for empirically realistic risk attitudes, providing results on Pareto optimality, competitive equilibria, utility frontiers, and the first and second theorems of welfare. Contrary to common theoretical assumptions, empirical studies find prevailing risk seeking in particular subdomains, in particular for losses. We first allow for some risk-seeking agents, still assuming expected utility. Yet more empirical realism is obtained by allowing agents to be neither risk averse nor risk seeking and by generalizing expected utility. Here we provide first results, pleading for future research. Our main new tool is a counter-monotonic improvement theorem.

Complexity vs Empirical Score

• Math Complexity: 8.5/10
• Empirical Rigor: 1.5/10
• Quadrant: Lab Rats — theoretically deep, empirically untested

Why this score: The paper provides strong mathematical contributions by proving a new counter-monotonic improvement theorem and extending Pareto optimality and welfare economics to non-concave, empirically realistic utility functions. However, it is purely theoretical with zero empirical validation or empirical data testing, making its practical backtesting rigor minimal.

Research Flowchart

  flowchart TD
    A["Research Goal: Analyze Optimal Risk Sharing under Empirically Realistic Risk Attitudes"] --> B["Data/Inputs: Empirical Findings of Risk Seeking & General Non-Expected Utility"]
    B --> C["Core Tool: Develop Counter-Monotonic Improvement Theorem"]
    C --> D["Methodology: Model Risk Allocation for Mixed Agents (Risk Averse & Risk Seeking)"]
    D --> E["Computational Process: Evaluate Pareto Optimality, Equilibria & Utility Frontiers"]
    E --> F["Key Findings: Extended Welfare Theorems & Pareto Baselines Beyond Standard Expected Utility"]