Risk Sharing with Multiple Indemnity Environments
European Journal of Operational Research, forthcoming
41 Pages Posted: 25 Jun 2020 Last revised: 8 Mar 2021
Date Written: February 21, 2021
Optimal risk sharing arrangements have been substantially studied in the literature, from the aspects of generalizing objective functions, incorporating more business constraints, and investigating different optimality criteria. This paper proposes an insurance model with multiple risk environments. We study the case where the two agents are endowed with the Value-at-Risk or the Tail Value-at-Risk, or when both agents are risk-neutral but have heterogeneous beliefs regarding the underlying probability distribution. We show that layer-type indemnities, within each risk environment, are Pareto optimal, which may be environment-specific. From Pareto optimality, we get that the premium can be chosen in a given interval, and we propose to allocate the gains from risk sharing equally between the buyer and seller.
Keywords: Risk management, Optimal insurance, Multiple risk environments, Value-at-Risk, Tail Value-at-Risk, Heterogeneous beliefs, Environment-specific layer indemnities
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