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Optimal Prevention for Correlated Risks

Author

Listed:
  • Christophe Courbage

    (Haute Ecole de Gestion de Genève and University of Applied Sciences of Western Switzerland)

  • Henri Louberge

    (University of Geneva, Ecole Polytechnique Fédérale de Lausanne, and Swiss Finance Institute)

  • Richard Peter

    (Ludwig Maximilian University of Munich)

Abstract

This paper analyzes optimal prevention in a situation of multiple, possibly correlated risks. We focus on probability reduction (self-protection) so that correlation becomes endogenous. If prevention concerns only one risk, introducing a second exogenous risk increases the level of prevention expenditures, even if correlation is negative. If prevention expenditures may be invested for both risks, a substitution effect arises. Under non-increasing returns on self-protection, we find that increased dependence increases aggregate prevention expenditures, but not necessarily prevention expenditures for each risk due to differences in prevention efficiency. Similar results are found when considering changes in the severity of losses. Consequently, the comparative statics emphasize global effects versus allocation effects. Our results have strong policy implications, considering the numerous mandatory safety measures introduced by governments over the past years.

Suggested Citation

  • Christophe Courbage & Henri Louberge & Richard Peter, 2013. "Optimal Prevention for Correlated Risks," Swiss Finance Institute Research Paper Series 13-50, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp1350
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    File URL: http://ssrn.com/abstract=2308716
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    Cited by:

    1. Annette Hofmann & Richard Peter, 2016. "Self-Insurance, Self-Protection, and Saving: On Consumption Smoothing and Risk Management," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 83(3), pages 719-734, September.

    More about this item

    Keywords

    self-protection; multiple risks; correlation;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making

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