The efficient market price for increasing and decreasing risk is zero.
If you can find people with complementary attitudes toward risk. Your example does indeed create risk—but in a risk-averse world, nobody would want to buy those contracts. Insurance arises from large entities with high capital and thus high relative risk-neutrality assuming the risk of smaller, more risk-averse entities for a price. If this market can be made efficient, the profits thus gained may be small, but insofar as all private insurance-providing organizations should be risk-averse to survive, the profits cannot be driven to zero.
It may not even be the case that they are small—depending on the structure of the market, a sufficiently large and risk-neutral organization may be able to become something of a natural monopoly, with its size reinforcing its risk-neutrality, and any competitors having difficulty entering without being large at the outset.
Re: the human utility function, I think I agree. I’ve been interested in Eric Weinstein’s work on introducing gauge theory into preferences to make them usefully invariant, but I think you’re right that they are too fatally flawed to ultimately discern naturally.
Mainly agree—but don’t forget aggregation. You can get rid of risk even if everyone is risk-averse, just by replacing “whole ownership of few risky contracts” with “partial ownership of many risky contracts”.
In the example in this post, if I own LH and you own LT, and we are both risk averse, we gain from trading half our contracts to each other.
If you can find people with complementary attitudes toward risk. Your example does indeed create risk—but in a risk-averse world, nobody would want to buy those contracts. Insurance arises from large entities with high capital and thus high relative risk-neutrality assuming the risk of smaller, more risk-averse entities for a price. If this market can be made efficient, the profits thus gained may be small, but insofar as all private insurance-providing organizations should be risk-averse to survive, the profits cannot be driven to zero.
It may not even be the case that they are small—depending on the structure of the market, a sufficiently large and risk-neutral organization may be able to become something of a natural monopoly, with its size reinforcing its risk-neutrality, and any competitors having difficulty entering without being large at the outset.
Re: the human utility function, I think I agree. I’ve been interested in Eric Weinstein’s work on introducing gauge theory into preferences to make them usefully invariant, but I think you’re right that they are too fatally flawed to ultimately discern naturally.
Mainly agree—but don’t forget aggregation. You can get rid of risk even if everyone is risk-averse, just by replacing “whole ownership of few risky contracts” with “partial ownership of many risky contracts”.
In the example in this post, if I own LH and you own LT, and we are both risk averse, we gain from trading half our contracts to each other.