Parimutuel Insurance for Hedging against Catastrophic Risk

This paper examines whether parimutuels can hedge risk-averse people against catastrophic losses. Two optimal stake choice models are constructed. In the first model, where stakes of other players are exogenous, the dynamic optimal hedge is obtained. In the second model, the equilibrium of stake is derived by maximizing the representative agent’s expected utility. Given no transaction cost, participants in parimutuels are underinsured due to basis risk. The actual transaction cost for traditional insurance is found to be higher than the equivalent utility level implied by HuRLOs, suggesting that hedgers could be better off with HuRLOs than with traditional insurance.