Previous chapters have analyzed the implications of risk for the welfare and behavior of a decision-maker. We have investigated how an individual can manage risk and information. However, individual decision-making must always be situated within its broader economic context. The institutions and economic environment surrounding an individual can themselves be sources of uncertainty (e.g., the case of theft). Alternatively, the economic institutions affecting individual behavior are themselves subject to management. This includes the establishment of property rights, the development and enforcement of contracts among individuals, and the design and implementation of policy rules. Such schemes play an important role in risk management for two reasons. First, they condition the type and magnitude of risk exposure facing a particular individual. Second, they allow for risk transfers among individuals. These risk transfers can take many forms: risk sharing schemes as specified in contracts (e.g., the case of sharecropping under uncertainty); insurance protection (e.g., fire or medical insurance); limited liability rules (e.g., bankruptcy protection); or social safety nets (e.g., disaster relief managed by government or NGO). The design and implementation of risk transfer schemes among individuals are an important aspect of risk management. This chapter focuses on the economics and efficiency of such schemes.

We will first develop a general model of resource allocation among individuals. This will include individual risk management as well as risk transfers across individuals. This provides a basis for analyzing the efficiency of resource allocation, as well as the efficiency of risk transfers. The generality of the analysis...