An ergodic theorem for multi-period mutual insurance
John Armstrong
Abstract
Suppose there are $N$ heterogeneous agents in a market with idiosyncratic risks but no uninsurable systematic risk factors. These agents may agree arbitrary financial contracts with one another, subject to the condition that contracts are self-enforcing under coalitions of agents in a common state. We show that, under mild conditions, this uniquely determines the limiting utility of every agent as $N$ tends to infinity. The result is an ergodic theorem: as the population grows, the number of degrees of freedom in the problem collapses, so that agents in the same state are treated identically in the limit. We exhibit an explicit, practically realisable mechanism achieving this limit using only short-dated contracts. The model can be applied either to an economy of heterogeneous agents pooling idiosyncratic risk through self-enforcing contracts or to the design of optimal insurance products such as pensions.
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