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Preferences Yielding the "Precautionary Effect"

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  • Michel De Lara

    (CERMICS)

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    Abstract

    Consider an agent taking two successive decisions to maximize his expected utility under uncertainty. After his first decision, a signal is revealed that provides information about the state of nature. The observation of the signal allows the decision-maker to revise his prior and the second decision is taken accordingly. Assuming that the first decision is a scalar representing consumption, the \emph{precautionary effect} holds when initial consumption is less in the prospect of future information than without (no signal). \citeauthor{Epstein1980:decision} in \citep*{Epstein1980:decision} has provided the most operative tool to exhibit the precautionary effect. Epstein's Theorem holds true when the difference of two convex functions is either convex or concave, which is not a straightforward property, and which is difficult to connect to the primitives of the economic model. Our main contribution consists in giving a geometric characterization of when the difference of two convex functions is convex, then in relating this to the primitive utility model. With this tool, we are able to study and unite a large body of the literature on the precautionary effect.

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    File URL: http://arxiv.org/pdf/0907.4093
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    Paper provided by arXiv.org in its series Papers with number 0907.4093.

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    Date of creation: Jul 2009
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    Handle: RePEc:arx:papers:0907.4093

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    1. Gollier, Christian & Jullien, Bruno & Treich, Nicolas, 2000. "Scientific progress and irreversibility: an economic interpretation of the 'Precautionary Principle'," Journal of Public Economics, Elsevier, vol. 75(2), pages 229-253, February.
    2. EECKHOUDT, Louis & GOLLIER, Christian & TREICH, Nicolas, . "Optimal consumption and the timing of the resolution of uncertainty," CORE Discussion Papers RP -1792, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    3. Pindyck, Robert S., 2000. "Irreversibilities and the timing of environmental policy," Resource and Energy Economics, Elsevier, vol. 22(3), pages 233-259, July.
    4. Kolstad, Charles D., 1996. "Fundamental irreversibilities in stock externalities," Journal of Public Economics, Elsevier, vol. 60(2), pages 221-233, May.
    5. Robert A. Jones & Joseph M. Ostroy, 1979. "Flexibilty and Uncertainty," UCLA Economics Working Papers 163, UCLA Department of Economics.
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