Forms of risk-sharing

The economic theory of decision-making under uncertainty and riskbearing rests on the assumption that individual agents behave consistently. If preferences do not depend upon the state of nature and if there exist opportunities for gambling at fair odds (say, on the stock market, or through private bets), then consistent behaviour implies aversion, or at least neutrality, towards economic risks (cf. Drèze (1971)). Casual empiricism confirms that risk aversion is indeed the rule: most individuals seem eager to shed their risks, even at unfair odds.

These risks take many forms, and affect an individual's health, his wealth, his liability, etc. Risk-shedding is achieved mainly through diversification, exchange or insurance. Each one of these three devices is limited in scope.

Diversification consists in splitting a risk into components with limited stochastic dependence, thereby reducing the total variance. Asset portfolios provide an example. But diversification entails costs of information and transactions. And an element of stochastic dependence is always present on the level of general economic activity: collective risks (as opposed to individual risks) cannot be eliminated through diversification.

Exchange sometimes enables strongly risk-averse individuals to sell their risks to other agents who are more tolerant or endowed with complementary risks. Futures markets enable buyers and sellers to shed price uncertainties (but not quantity uncertainties). Equity financing is a way of selling business risks. But exchange must take place before the relevant information becomes available (once a lottery is drawn, there is no market any more for its tickets).