Risk-sharing Contracts with Asymmetric Information

We examine how risk-sharing is impacted by asymmetric information on the probability distribution of wealth. We define the optimal incentive compatible agreements in a two-agent model with two levels of wealth. When there is complete information on the probability of the different outcomes, the resulting allocation satisfies the mutuality principle (which states that everyone's final wealth depends only upon the aggregate wealth of the economy). This is no longer true when agents have private information regarding their probability distribution of wealth. Asymmetry of information (i) makes ex-post equal sharing unsustainable between two low-risk agents, and (ii) induces exchanges when agents have the same realization of wealth. The Geneva Risk and Insurance Review (2012) 37, 27-56. doi:10.1057/grir.2011.2; published online 22 March 2011