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Lecture 06 - Risk Pooling I

# Lecture 06 - Risk Pooling I - Risk Pooling Two people with...

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Risk Pooling Risk Pooling Two people with same distribution of losses Assume losses are independent (uncorrelated) Outcome Probability \$0 0.95 Loss = \$10,000 0.05

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Risk Pooling Risk Pooling Under a risk pooling arrangement, the 2 people agree to share equally any losses experienced by either person Loss i = (Loss 1 +Loss 2 )/2 = Average loss of group
Logic of Risk Pooling Logic of Risk Pooling Risk pooling allows each member of the pool to face only the probability distribution of average losses per person rather than the probability distribution of individual losses Average Loss = Sum of individual losses Number in Pool What is the probability distribution of average losses per person in the pool?

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Possible Outcomes under Pooling Possible Outcomes under Pooling Person 1 Person 2 Total Loss Average
Risk Pooling Example with 2 People Risk Pooling Example with 2 People Loss for Each Person in the Pool

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Effects of Risk Pooling Effects of Risk Pooling A: Each Person Alone Outcome Probability \$0 0.95 \$10,000 0.05 B: Pooling with 2 People Outcome Probability \$0 0.9025 \$5,000 0.095 \$10,000 0.0025
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