Bilateral Risk Sharing with No Aggregate Uncertainty under Rank-Dependent Utility

Abstract

This paper studies bilateral risk-sharing with no aggregate uncertainty, when agents maximize rank-dependent utilities. We characterize the structure of Pareto optimal risk-sharing contracts in full generality. We then derive a necessary and sufficient condition for Pareto optima to be no-betting allocations (i.e., deterministic allocations), thereby answering the question of when sunspots do not exist in this economy. This condition depends only on the probability weighting functions of the two agents, and not on their (concave) utility functions.

Keywords: Risk Sharing, Pareto Optimality, Sunspots, Rank-Dependent Utility

JEL Classification: C02, D86, G22