The Value of Risk Reduction: New Tools for an Old Problem
AbstractThe relationship between willingness to pay (WTP) to reduce the probability of an adverse event and the degree of risk aversion is ambiguous. The ambiguity arises because paying for protection worsens the outcome in the event the adverse event occurs, which influences the expected marginal utility of wealth. Using concepts of prudence (equivalently, downside risk aversion), we characterize the marginal WTP to reduce the probability of the adverse event as the product of WTP in the case of risk neutrality and an adjustment factor. For the univariate case (e.g., risk of financial loss), the adjustment factor depends on risk aversion and prudence with respect to wealth. For the bivariate case (e.g., risk of death or illness), the adjustment factor depends on risk aversion and cross-prudence in wealth.
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Bibliographic InfoPaper provided by IESEG School of Management in its series Working Papers with number 2013-ECO-13.
Length: 12 pages
Date of creation: Jun 2013
Date of revision:
value per statistical life; mortality risk; risk aversion; prudence;
Find related papers by JEL classification:
- D8 - Microeconomics - - Information, Knowledge, and Uncertainty
- I1 - Health, Education, and Welfare - - Health
This paper has been announced in the following NEP Reports:
- NEP-AGE-2013-07-20 (Economics of Ageing)
- NEP-ALL-2013-07-20 (All new papers)
- NEP-MIC-2013-07-20 (Microeconomics)
- NEP-RMG-2013-07-20 (Risk Management)
- NEP-UPT-2013-07-20 (Utility Models & Prospect Theory)
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