Optimal risk sharing, equilibria, and welfare with empirically realistic risk attitudes

Abstract: This paper examines optimal risk sharing for empirically realistic risk attitudes, providing results on Pareto optimality, competitive equilibria, utility frontiers, and the first and second theorems of welfare. Empirical studies suggest, contrary to classical assumptions, that risk seeking is prevalent in particular subdomains, and is even the majority finding for losses, underlying for instance the disposition effect. We first analyze cases of expected utility agents, some of whom may be risk seeking. Yet more empirical realism is obtained by allowing agents to be risk averse in some subdomains but risk seeking in others, which requires generalizing expected utility. Here we provide first results, pleading for future research. Our main new tool for analyzing generalized risk attitudes is a counter-monotonic improvement theorem.