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Expected Utility theory and the tyranny of catastrophic risks

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  • Buchholz, Wolfgang
  • Schymura, Michael

Abstract

Expected Utility theory is not only applied to individual choices but also to ethical decisions, e.g. in cost-benefit analysis of climate change policy measures that affect future generations. In this context the crucial question arises whether EU theory is able to deal with 'catastrophic risks', i.e. risks of high, but very unlikely losses, in an ethically appealing way. In this paper we show that this is not the case. Rather, if in the framework of EU theory a plausible level of risk aversion is assumed, a 'tyranny of catastrophic risk' (TCR) emerges, i.e. project evaluation may be dominated by the catastrophic event even if its probability is negligibly small. With low degrees of risk aversion, however the catastrophic risk eventually has no impact at all when its probability goes to zero which is ethically not acceptable as well. --

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Paper provided by ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research in its series ZEW Discussion Papers with number 10-059.

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Date of creation: 2010
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Handle: RePEc:zbw:zewdip:10059

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Keywords: utilitarianism; Expected Utility theory; catastrophic risks;

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Cited by:
  1. Frank Ackerman & Elizabeth Stanton & Ramón Bueno, 2013. "Epstein–Zin Utility in DICE: Is Risk Aversion Irrelevant to Climate Policy?," Environmental & Resource Economics, European Association of Environmental and Resource Economists, vol. 56(1), pages 73-84, September.
  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. Thomas Michielsen, 2013. "Environmental Catastrophes under Time-Inconsistent Preferences," Working Papers 2013.55, Fondazione Eni Enrico Mattei.
  4. Edilio Valentini & Paolo Vitale, 2014. "Optimal Climate Policy for a Pessimistic Social Planner," Working Papers 2014.33, Fondazione Eni Enrico Mattei.
  5. Michielsen, T.O., 2013. "Environmental Catastrophes Under Time-inconsistent Preferences," Discussion Paper 2013-013, Tilburg University, Center for Economic Research.

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