Second-best risk sharing with incomplete contracts.

Summary In this paper, we examine Pareto-efficient risk allocations in the presence of constraints on contract form. In a first model, there are two sources of risk, but risk sharing can only be done on the first one. We look for conditions such that it is Pareto-efficient for the agent who bears the non-transferable risk to receive less than 50% of the transferable risk. We show that the decrease in absolute prudence is necessary and sufficient. In a second model, we study risk sharing in a mutual insurance company in which some members do not have access to the financial markets that allow partial diversification.