The Allocation of Individual Risks in Large Markets

Abstract

The modern theory of risk-bearing, as introduced by Arrow [1], Baudier [3] and Debreu [4], although fully general, gives no direct justification for a proposition that common sense suggests: an optimal allocation of resources typically requires that firms ought to maximise the expected value of their profits, and a contrario risk aversion at the level of the individual firm is detrimental to efficiency. It is very revealing that this proposition had to be argued by one of the founders of the modern theory against one of its adepts, namely by Arrow and Lind [2] against Hirshleifer [6]. One may also note that the modern approach does not directly exhibit the role of insurance for a proper allocation of resources. Such a role was often emphasised, for instance by F. Knight [7]. To a very large extent a system of insurance can replace the markets for contingent commodities, which were imagined by the theory but hardly exist in fact.

The author has benefited from useful comments made by P. Champsaur, B. Grodal, C. Henry and a referee.