Aggregate risks and insurance with heterogeneous agents

Abstract This paper explores whether insurance against aggregate risk is effective in economies with heterogeneous agents. While aggregate shocks are typically viewed as uninsurable, we show that insurance becomes effective when agents differ in productivity or initial wealth. We develop a two‐period general equilibrium model with a CES production technology and Greenwood–Hercowitz–Huffman preferences. Insurance is effective only when heterogeneity generates asymmetric income responses, in which case state‐contingent claims restore Pareto efficiency. Quantitative results show that welfare gains arise only with heterogeneity and are larger for agents further from the average. Moreover, welfare gains increase with dispersion, while the effect of average exposure is non‐monotonic due to general‐equilibrium price adjustments.