DECREASING ABSOLUTE PRUDENCE - CHARACTERIZATION AND APPLICATIONS TO 2ND-BEST RISK SHARING

In this paper, we provide two basic properties of utility functions u which exhibit decreasing absolute prudence, i.e. (-utriple prime/u '') ' less than or equal to 0. These properties are used to examine the al location of risks in an economy when some agents bear non-transferable risks. We show that it is fair Pareto-efficient to let those with a n on-transferable risk bear relatively less of the transferable risk in the economy if and only if absolute prudence is decreasing. In another model, there is a complete set of contingent markets, but some agents have no direct access to them. We examine the fair efficient allocati on of risk in a pool gathering a trader and a non-trader. Decreasing a bsolute prudence provides an upper bound to the share of the pool's ri sk that should be borne by the trader.