risk sharing

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The sharing of risk between economic agents. Suppose a firm wishes to finance a risky project. If it uses its own money, it bears all the risk itself. If it issues equity capital to finance x percent of the project, x percent of the risk is borne by whoever buys the shares. Similarly, the government shares risks among taxpayers. Consider the government investing in a risky project. If the project performs badly any losses (or costs in excess of budget) are met by the taxpayers. This ability of the government to share risk has been used to argue that the government should act as if it were risk-neutral. Efficient risk sharing arises when the risk is allocated to the least risk-averse agents. Hence, efficient risk sharing between a risk-averse worker and a risk-neutral firm will allocate all the risk to the firm.

Subjects: Economics.

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