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The Diversification Theorem Restated: Risk-pooling Without Assignment of Probabilities

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  • Göran Skogh
  • Hong Wu

Abstract

Bayesian decision theory assumes that agents making choices assign subjective probabilities to outcomes, even in cases where information on probabilities is obviously absent. Here we show that agents that presume that they are equal risks can share risks mutually beneficially, even if the probabilities of losses are unpredictable or genuinely uncertain. We show also that different risk aversions among pool members do not exclude mutually beneficial loss sharing at uncertainty. Sharing when individuals’ losses differ in probabilities or in amount may still make individuals better off. Our findings are related to the theory of the insurance firm, to the management of development risks, and to the theory of justice. Copyright Springer Science + Business Media, Inc. 2005

Suggested Citation

  • Göran Skogh & Hong Wu, 2005. "The Diversification Theorem Restated: Risk-pooling Without Assignment of Probabilities," Journal of Risk and Uncertainty, Springer, vol. 31(1), pages 35-51, July.
    • Handle: RePEc:kap:jrisku:v:31:y:2005:i:1:p:35-51
    DOI: 10.1007/s11166-005-2929-0
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    References listed on IDEAS

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    1. Roth, Alvin E & Rothblum, Uriel G, 1982. "Risk Aversion and Nash's Solution for Bargaining Games with Risky Outcomes," Econometrica, Econometric Society, vol. 50(3), pages 639-647, May.
    2. Rothschild, Michael & Stiglitz, Joseph E., 1971. "Increasing risk II: Its economic consequences," Journal of Economic Theory, Elsevier, vol. 3(1), pages 66-84, March.
    3. Goeran Skogh, 1999. "Risk-Sharing Institutions for Unpredictable Losses," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 155(3), pages 505-505, September.
    4. Göran Skogh, 1998. "Development Risks, Strict Liability, and the Insurability of Industrial Hazards," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 23(2), pages 247-264, April.
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    Cited by:

    1. Vijay Aseervatham & Patricia Born & Dominik Lohmaier & Andreas Richter, 2017. "Hazard-Specific Supply Reactions in the Aftermath of Natural Disasters," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 42(2), pages 193-225, April.
    2. Michel Denuit & Jan Dhaene & Christian Y. Robert, 2022. "Risk‐sharing rules and their properties, with applications to peer‐to‐peer insurance," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 89(3), pages 615-667, September.
    3. Michael Faure & Donatella Porrini, 2017. "Göran Skogh on Risk Sharing and Environmental Policy," The Geneva Papers on Risk and Insurance - Issues and Practice, Palgrave Macmillan;The Geneva Association, vol. 42(2), pages 177-192, April.
    4. Lundtofte, Frederik, 2015. "Banks’ pooling of corporate debt: An application of the restated diversification theorem," The North American Journal of Economics and Finance, Elsevier, vol. 31(C), pages 249-263.
    5. Payandeh Najafabadi, Amir T. & Bazaz, Ali Panahi, 2016. "An optimal co-reinsurance strategy," Insurance: Mathematics and Economics, Elsevier, vol. 69(C), pages 149-155.
    6. Ali Ahmed & Göran Skogh, 2006. "Choices at various levels of uncertainty: An experimental test of the restated diversification theorem," Journal of Risk and Uncertainty, Springer, vol. 33(3), pages 183-196, December.

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