Cooperative Investment in Incomplete Markets Under Financial Fairness

32 Pages Posted: 1 Jul 2014 Last revised: 27 Sep 2016

See all articles by Jaroslav Pazdera

Jaroslav Pazdera

Tilburg University - Center for Economic Research (CentER)

J. M. Schumacher

University of Amsterdam - Department of Quantitative Economics (KE)

Bas J. M. Werker

Tilburg University - Center for Economic Research (CentER)

Date Written: September 19, 2016

Abstract

Groups of agents, such as participants in a collective pension fund, can decide to undertake a joint investment and to define, ex ante, a rule for the division of proceeds. The collective investment decision and the allocation rule together form a risk sharing scheme. Such a scheme defines a contingent claim for each participant. Given a proposed risk sharing scheme and an agreed-upon pricing functional, the values of these claims can be determined and can be compared to the values of the contributions made by the agents. A risk sharing scheme is said to be financially fair if, for each agent, the value of the agent’s claim as defined by the scheme is equal to the value of the agent’s contribution. The paper provides conditions under which there exists a unique risk sharing scheme that is both Pareto efficient (in the sense of expected utility) and financially fair. Furthermore, an iterative algorithm is presented by which this scheme can be computed. The theory is illustrated by a simple example which shows that, in an incomplete financial market, agents may benefit substantially from forming a collective.

Suggested Citation

Pazdera, Jaroslav and Schumacher, J.M. (Hans) and Werker, Bas J.M., Cooperative Investment in Incomplete Markets Under Financial Fairness (September 19, 2016). Netspar Discussion Paper No. 05/2014-016, Available at SSRN: https://ssrn.com/abstract=2460649 or http://dx.doi.org/10.2139/ssrn.2460649

Jaroslav Pazdera

Tilburg University - Center for Economic Research (CentER) ( email )

J.M. (Hans) Schumacher (Contact Author)

University of Amsterdam - Department of Quantitative Economics (KE) ( email )

Roetersstraat 11
Amsterdam, 1018 WB
Netherlands

Bas J.M. Werker

Tilburg University - Center for Economic Research (CentER) ( email )

Econometrics and Finance Group
5000 LE Tilburg
Netherlands

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