Risk Sharing with Rank-dependent Utility

Abstract

Risk-averse agents prefer to be fully insured against the fluctuations on their endowments. One way to avoid consumption risks is to agree upon endowment transfers among them. This kind of informal insurance is what we call a risk sharing. Over an infinite time horizon, the agents can be better off through risk sharing if they are sufficiently patient. We extend Mailath and Samuelson (2006) by allowing types of agents. A standard agent may benefit from having a pessimistic agent under rank-dependent utility as his risk sharing partner. Furthermore, it is much easier for them to have full insurance in equilibrium. We characterize a lower bound of the efficient frontier when the two agents are not patient enough. We also present our results with numerical examples.