Private Risk

Abstract

We extend the traditional decision analytic approach to calculation of the buying (selling) price of a lottery by allowing a risk averse (risk prone) decision maker to rebalance his financial portfolio in the course of determination of these prices. Building on the classical portfolio allocation problem in complete markets, we generalize the standard treatment to include both traded and non-traded unique risks. Our principal focus is on private risks-risks that are not tradable or traded in financial markets. We show that allowing portfolio rebalancing in a distributive bargaining setting with risk averse negotiators expands the zone of possible agreement [ZOPA] relative to the ZOPA yielded when rebalancing is not allowed.