The Bargaining Set of a Reinsurance Market

Extract

This paper uses the same notations and some of the results of Baton and Lemaire (1981). The reader is referred to that work for more details about the classical risk exchange model, which will not be recalled here. The main result of that former paper was to characterize the core of the market in the case of exponential utilities, and to show that it is never empty. Since the core always exists, and since it is such an intuitive notion, one might wonder why we introduce here a much more complicated concept. The reason is that the core is presently subject to a heavy fire of criticisms–both experimental and theoretical–from leading researchers in game theory; they claim that the core is much too static, that it does not take into account the real dynamics of the bargaining process, that it does not introduce the full spectrum of negotiation threats of the traders. Indeed, experimental data consistently produce final payoffs that lie outside the core, but within the bargaining set (abbreviated: b.s.). We shall attempt to illustrate those criticisms in 4. We shall define the b.s. in a general non transferable game in 2, and characterize it in the special case of a 3-company reinsurance market in 3, but first of all we would like to explain intuitively the basic mechanisms of the b.s. by means of a simple example (with transferable utilities).

The basic difficulty in modelling a negotiation process is to express what is the purpose of the game. Certainly, the objective is not just to get the maximal amount of profits, because if everyone demands the highest payoff he can obtain in a coalition, no agreement will be reached; the goal of the process is to attain some state of stability, to which the bargainers should agree if they want any agreement to be enforced. This stability should reflect in some way the power of each player, which results from the rules of the game, his initial situation, his attitude towards risk, …

A bargaining process is a multi-criteria situation, in which the players certainly attempt to maximize their payoffs, but also try to enter into a “safe” or “stable” coalition.