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Expected Utility and Catastrophic Risk

Author

Listed:
  • Masako Ikefuji

    (University of Southern Denmark, Denmark)

  • Roger Laeven

    (University of Amsterdam, the Netherlands)

  • Jan Magnus

    (VU University Amsterdam, the Netherlands)

  • Chris Muris

    (Simon Fraser University, Canada)

Abstract

An expected utility based cost-benefit analysis is in general fragile to its distributional assumptions. We derive necessary and sufficient conditions on the utility function of the expected utility model to avoid this. The conditions ensure that expected (marginal) utility remains finite also under heavy-tailed distributional assumptions. Our results are context-free and are relevant to many fields encountering catastrophic risk analysis, such as, perhaps most noticeably, insurance and risk management.

Suggested Citation

  • Masako Ikefuji & Roger Laeven & Jan Magnus & Chris Muris, 2014. "Expected Utility and Catastrophic Risk," Tinbergen Institute Discussion Papers 14-133/III, Tinbergen Institute.
    • Handle: RePEc:tin:wpaper:20140133
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    File URL: https://papers.tinbergen.nl/14133.pdf
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    References listed on IDEAS

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    Cited by:

    1. Ikefuji, M. & Laeven, R.J.A. & Magnus, J.R. & Muris, C.H.M., 2010. "Scrap Value Functions in Dynamic Decision Problems," Discussion Paper 2010-77, Tilburg University, Center for Economic Research.
    2. Chanel, Olivier & Chichilnisky, Graciela, 2013. "Valuing life: Experimental evidence using sensitivity to rare events," Ecological Economics, Elsevier, vol. 85(C), pages 198-205.
    3. Auke Hoekstra & Maarten Steinbuch & Geert Verbong, 2017. "Creating Agent-Based Energy Transition Management Models That Can Uncover Profitable Pathways to Climate Change Mitigation," Complexity, Hindawi, vol. 2017, pages 1-23, December.
    4. David Comerford, 2013. "A balance of questions: what can we ask of climate change economics?," Edinburgh School of Economics Discussion Paper Series 216, Edinburgh School of Economics, University of Edinburgh.

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    More about this item

    Keywords

    Expected utility; Catastrophe; Cost-benefit analysis; Risk management; Power utility; Exponential utility; Heavy tails;
    All these keywords.

    JEL classification:

    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • Q5 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics

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