Peer-to-Peer Risk Sharing with an Application to Flood Risk Pooling

Abstract

In contrast with classic centralized risk sharing, a novel peer-to-peer risk sharing framework is proposed. The presented framework aims to devise a risk allocation mechanism that is structurally decentralized, Pareto optimal, and mathematically fair. An explicit form for the pool allocation ratio matrix is derived, and convex programming techniques are applied to determine the optimal pooling mechanism in a constrained variance reduction setting. A tiered hierarchical generalization is also constructed to improve computational efficiency. As an illustration, these techniques are applied to a flood risk pooling example. It is shown that peer-to-peer risk sharing techniques provide an economically viable alternative to traditional flood policies.