COMPETITIVE EQUILIBRIA with DISTORTION RISK MEASURES

Abstract

This paper studies optimal risk redistribution between firms, such as banks or insurance companies. The introduction of the Basel II regulation and the Swiss Solvency Test has increased the use of risk measures to evaluate financial or insurance risk. We consider the case where firms use a distortion risk measure (also called dual utility) to evaluate risk. The paper first characterizes all Pareto optimal redistributions. Thereafter, it characterizes all competitive equilibria. It presents three conditions that are jointly sufficient for existence of a unique equilibrium redistribution. This equilibrium's redistribution and prices are provided in closed form via a representative agent.