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

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Author Info
Toshihiro Ihori (Faculty of Economics, University of Tokyo)
Martin C. McGuire (Department of Economics, University of California-Irvine)
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.

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Paper provided by CIRJE, Faculty of Economics, University of Tokyo in its series CIRJE F-Series with number CIRJE-F-402.

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Length: 43pages
Date of creation: Mar 2006
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Handle: RePEc:tky:fseres:2006cf402

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  1. 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. [Downloadable!]
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