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Collective Risk Control and Group Security: The Unexpected Consequences of Differential Risk Aversion

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  • TOSHIHIRO IHORI
  • MARTIN C. McGUIRE

Abstract

We provide an analysis of odds-improving self-protection for when it yields collective benefits to groups, such as alliances of nations, for whom risks of loss are public bads and prevention of loss is a public good. Our analysis of common risk reduction shows how diminishing returns in risk improvement can be folded into income effects. These income effects then imply that whether protection is inferior or normal depends on the risk aversion characteristics of underlying utility functions, and on the interaction between these, the level of risk, and marginal effectiveness of risk abatement. We demonstrate how public good inferiority is highly likely when the good is "group risk reduction." In fact, we discover a natural or endogenous limit on the size of a group and of the amount of risk controlling outlay it will provide under Nash behavior. We call this limit an "Inferior Goods Barrier" to voluntary risk reduction. For the paradigm case of declining risk aversion, increases in group size(wealth) will cause provision of more safety to change from a normal to an inferior good thereby creating such a barrier. Copyright 2007 Blackwell Publishing, Inc..

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Bibliographic Info

Article provided by Association for Public Economic Theory in its journal Journal of Public Economic Theory.

Volume (Year): 9 (2007)
Issue (Month): 2 (04)
Pages: 231-263

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Handle: RePEc:bla:jpbect:v:9:y:2007:i:2:p:231-263

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Citations

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Cited by:
  1. Tim Lohse & Julio R. Robledo & Ulrich Schmidt, 2012. "Self‐Insurance and Self‐Protection as Public Goods," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 79(1), pages 57-76, 03.
  2. Toshihiro Ihori & Martin McGuire, 2006. "Patterns of Non-exponential Growth of Macroeconomic Models: Two-parameter Poisson-Dirichlet Models," CIRJE F-Series CIRJE-F-450, CIRJE, Faculty of Economics, University of Tokyo.
  3. Lohse, Tim & Robledo, Julio R., 2012. "Public self-insurance and the Samaritan's dilemma in a federation," Discussion Papers, Research Professorship & Project "The Future of Fiscal Federalism" SP II 2012-103, Social Science Research Center Berlin (WZB).
  4. Yamamoto, Wataru, 2013. "Negative economic consequences of ethical campaigns?: Market data evidence," MPRA Paper 49070, University Library of Munich, Germany.
  5. Heike Auerswald & Kai A. Konrad & Marcel Thum, 2011. "Adaptation, Mitigation and Risk-Taking in Climate Policy," CESifo Working Paper Series 3320, CESifo Group Munich.
  6. Martin C. McGuire, 2010. "Economic Analysis and International Security," Public Policy Review, Policy Research Institute, Ministry of Finance Japan, vol. 6(2), pages 313-346, March.
  7. Toshihiro Ihori & Martin McGuireb, 2008. "National Adversity: Managing Insurance and Protection," CIRJE F-Series CIRJE-F-554, CIRJE, Faculty of Economics, University of Tokyo.
  8. Toshihiro Ihori & Martin McGuire, 2006. "Group Provision Against Adversity: Security By Insurance vs. Protection," CARF F-Series CARF-F-086, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
  9. David Rietzke & Brian Roberson, 2013. "The robustness of ‘enemy-of-my-enemy-is-my-friend’ alliances," Social Choice and Welfare, Springer, vol. 40(4), pages 937-956, April.

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