IDEAS home Printed from https://ideas.repec.org/a/bla/jrinsu/v88y2021i3p695-725.html
   My bibliography  Save this article

Should we do more when we know less? The effect of technology risk on optimal effort

Author

Listed:
  • Lu Li
  • Richard Peter

Abstract

Technology risk arises when the effectiveness of self‐insurance and self‐protection activities depends on exogenous factors or is only imperfectly known. It affects optimal behavior via a preference channel and a technology channel. In this paper, we identify conditions for unambiguous comparative statics with respect to the presence of, as well as various stochastic changes in technology risk. These conditions involve prudence, relative risk aversion, relative prudence, and several new measures of mitigation efficacy. We highlight cases where technology risk raises the optimal level of effort, consistent with the precautionary principle. We discuss several applications of our results.

Suggested Citation

  • Lu Li & Richard Peter, 2021. "Should we do more when we know less? The effect of technology risk on optimal effort," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 88(3), pages 695-725, September.
    • Handle: RePEc:bla:jrinsu:v:88:y:2021:i:3:p:695-725
    DOI: 10.1111/jori.12339
    as

    Download full text from publisher

    File URL: https://doi.org/10.1111/jori.12339
    Download Restriction: no
    File URL: https://libkey.io/10.1111/jori.12339?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Joshua Schwartzstein, 2014. "Selective Attention And Learning," Journal of the European Economic Association, European Economic Association, vol. 12(6), pages 1423-1452, December.
    2. Toman, Michael & Shogren, Jason, 2000. "Climate Change Policy," RFF Working Paper Series dp-00-22, Resources for the Future.
    3. Kimball, Miles S, 1990. "Precautionary Saving in the Small and in the Large," Econometrica, Econometric Society, vol. 58(1), pages 53-73, January.
    4. Courbage, Christophe & Rey, Béatrice, 2012. "Optimal prevention and other risks in a two-period model," Mathematical Social Sciences, Elsevier, vol. 63(3), pages 213-217.
    5. MOSSIN, Jan, 1968. "Aspects of rational insurance purchasing," LIDAM Reprints CORE 23, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    6. Georges Dionne (ed.), 2013. "Handbook of Insurance," Springer Books, Springer, edition 2, number 978-1-4614-0155-1, November.
    7. Bond, Eric W. & Crocker, Keith J., 1997. "Hardball and the soft touch: The economics of optimal insurance contracts with costly state verification and endogenous monitoring costs," Journal of Public Economics, Elsevier, vol. 63(2), pages 239-264, January.
    8. Daniel J. Clarke, 2016. "A Theory of Rational Demand for Index Insurance," American Economic Journal: Microeconomics, American Economic Association, vol. 8(1), pages 283-306, February.
    9. Courbage, Christophe & Rey, Béatrice & Treich, Nicolas, 2013. "Prevention and precaution," IDEI Working Papers 805, Institut d'Économie Industrielle (IDEI), Toulouse.
    10. Block, M K & Heineke, J M, 1973. "The Allocation of Effort under Uncertainty: The Case of Risk-averse Behavior," Journal of Political Economy, University of Chicago Press, vol. 81(2), pages 376-385, Part I, M.
    11. Jean-Marc Bourgeon & Pierre Picard, 2014. "Fraudulent Claims and Nitpicky Insurers," American Economic Review, American Economic Association, vol. 104(9), pages 2900-2917, September.
    12. Louis Eeckhoudt & Liqun Liu & Jack Meyer, 2017. "Restricted increases in risk aversion and their application," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 64(1), pages 161-181, June.
    13. Kocher, Martin G. & Lahno, Amrei Marie & Trautmann, Stefan T., 2018. "Ambiguity aversion is not universal," European Economic Review, Elsevier, vol. 101(C), pages 268-283.
    14. David S. Loughran, 2005. "Deterring Fraud: The Role of General Damage Awards in Automobile Insurance Settlements," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 72(4), pages 551-575, December.
    15. Tennyson, Sharon, 1997. "Economic institutions and individual ethics: A study of consumer attitudes toward insurance fraud," Journal of Economic Behavior & Organization, Elsevier, vol. 32(2), pages 247-265, February.
    16. Aurélien Baillon & Aysil Emirmahmutoglu, 2018. "Zooming In On Ambiguity Attitudes," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 59(4), pages 2107-2131, November.
    17. Keith J. Crocker & John Morgan, 1998. "Is Honesty the Best Policy? Curtailing Insurance Fraud through Optimal Incentive Contracts," Journal of Political Economy, University of Chicago Press, vol. 106(2), pages 355-375, April.
    18. Seth Neumuller & Casey Rothschild, 2017. "Financial Sophistication and Portfolio Choice over the Life Cycle," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 26, pages 243-262, October.
    19. Wenan Fei & Harris Schlesinger, 2008. "Precautionary Insurance Demand With State‐Dependent Background Risk," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 75(1), pages 1-16, March.
    20. Eeckhoudt, Louis & Schlesinger, Harris, 2008. "Changes in risk and the demand for saving," Journal of Monetary Economics, Elsevier, vol. 55(7), pages 1329-1336, October.
    21. W. Chiu & Louis Eeckhoudt, 2010. "The effects of stochastic wages and non-labor income on labor supply: update and extensions," Journal of Economics, Springer, vol. 100(1), pages 69-83, May.
    22. W. Chiu & Louis Eeckhoudt & Beatrice Rey, 2012. "On relative and partial risk attitudes: theory and implications," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 50(1), pages 151-167, May.
    23. Cheng, Hsueh-Cheng & Magill, Michael J P & Shafer, Wayne J, 1987. "Some Results on Comparative Statics under Uncertainty," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 28(2), pages 493-507, June.
    24. Hoy, Michael, 1989. "The value of screening mechanisms under alternative insurance possibilities," Journal of Public Economics, Elsevier, vol. 39(2), pages 177-206, July.
    25. Peter, Richard & Ying, Jie, 2020. "Do you trust your insurer? Ambiguity about contract nonperformance and optimal insurance demand," Journal of Economic Behavior & Organization, Elsevier, vol. 180(C), pages 938-954.
    26. Courbage, Christophe & Rey, Béatrice, 2012. "Priority setting in health care and higher order degree change in risk," Journal of Health Economics, Elsevier, vol. 31(3), pages 484-489.
    27. Gollier, Christian & Treich, Nicolas, 2003. "Decision-Making under Scientific Uncertainty: The Economics of the Precautionary Principle," Journal of Risk and Uncertainty, Springer, vol. 27(1), pages 77-103, August.
    28. David Crainich & Louis Eeckhoudt, 2017. "Average willingness to pay for disease prevention with personalized health information," Journal of Risk and Uncertainty, Springer, vol. 55(1), pages 29-39, August.
    29. Kunreuther, Howard & Heal, Geoffrey, 2003. "Interdependent Security," Journal of Risk and Uncertainty, Springer, vol. 26(2-3), pages 231-249, March-May.
    30. Louis Eeckhoudt & Rachel J. Huang & Larry Y. Tzeng, 2012. "Precautionary Effort: A New Look," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 79(2), pages 585-590, June.
    31. Qin Lian & Harris Schlesinger, 2012. "Insurance Contract Design When the Insurer Has Private Information on Loss Size," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 79(4), pages 1039-1050, December.
    32. Donald Meyer & Jack Meyer, 2005. "Relative Risk Aversion: What Do We Know?," Journal of Risk and Uncertainty, Springer, vol. 31(3), pages 243-262, December.
    33. Hadar, Josef & Seo, Tae Kun, 1990. "The Effects of Shifts in a Return Distribution on Optimal Portfolios," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 31(3), pages 721-736, August.
    34. Johanna Etner & Sandrine Spaeter, 2010. "The impact of ambiguity on health prevention and insurance," Working Papers of BETA 2010-08, Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg.
    35. Rothschild, Michael & Stiglitz, Joseph E., 1970. "Increasing risk: I. A definition," Journal of Economic Theory, Elsevier, vol. 2(3), pages 225-243, September.
    36. Dardanoni, Valentino & Wagstaff, Adam, 1990. "Uncertainty and the demand for medical care," Journal of Health Economics, Elsevier, vol. 9(1), pages 23-38, June.
    37. Lusardi, Annamaria & Mitchell, Olivia S., 2011. "Financial literacy around the world: an overview," Journal of Pension Economics and Finance, Cambridge University Press, vol. 10(4), pages 497-508, October.
    38. David Alary & Christian Gollier & Nicolas Treich, 2013. "The Effect of Ambiguity Aversion on Insurance and Self‐protection," Economic Journal, Royal Economic Society, vol. 123(12), pages 1188-1202, December.
    39. Dionne, Georges & Eeckhoudt, Louis, 1985. "Self-insurance, self-protection and increased risk aversion," Economics Letters, Elsevier, vol. 17(1-2), pages 39-42.
    40. Loïc Berger & Johannes Emmerling & Massimo Tavoni, 2017. "Managing Catastrophic Climate Risks Under Model Uncertainty Aversion," Management Science, INFORMS, vol. 63(3), pages 749-765, March.
    41. Alexander Muermann & Howard Kunreuther, 2008. "Self-protection and insurance with interdependencies," Journal of Risk and Uncertainty, Springer, vol. 36(2), pages 103-123, April.
    42. Neil A. Doherty & Harris Schlesinger, 1990. "Rational Insurance Purchasing: Consideration of Contract Nonperformance," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 105(1), pages 243-253.
    43. Ekern, Steinar, 1980. "Increasing Nth degree risk," Economics Letters, Elsevier, vol. 6(4), pages 329-333.
    44. Hui Li & Seth Neumuller & Casey Rothschild, 2021. "Optimal annuitization with imperfect information about insolvency risk," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 88(1), pages 101-130, March.
    45. Rothschild, Michael & Stiglitz, Joseph E., 1971. "Increasing risk II: Its economic consequences," Journal of Economic Theory, Elsevier, vol. 3(1), pages 66-84, March.
    46. Gollier, Christian & Jullien, Bruno & Treich, Nicolas, 2000. "Scientific progress and irreversibility: an economic interpretation of the 'Precautionary Principle'," Journal of Public Economics, Elsevier, vol. 75(2), pages 229-253, February.
    47. Sally Kane & Jason Shogren, 2000. "Linking Adaptation and Mitigation in Climate Change Policy," Climatic Change, Springer, vol. 45(1), pages 75-102, April.
    48. Crocker, Keith J & Tennyson, Sharon, 2002. "Insurance Fraud and Optimal Claims Settlement Strategies," Journal of Law and Economics, University of Chicago Press, vol. 45(2), pages 469-507, October.
    49. Kit Pong Wong, 2019. "An interpretation of the condition for precautionary saving: the case of greater higher-order interest rate risk," Journal of Economics, Springer, vol. 126(3), pages 275-286, April.
    50. Maximilian Auffhammer, 2018. "Quantifying Economic Damages from Climate Change," Journal of Economic Perspectives, American Economic Association, vol. 32(4), pages 33-52, Fall.
    51. Stefano DellaVigna & Ulrike Malmendier, 2006. "Paying Not to Go to the Gym," American Economic Review, American Economic Association, vol. 96(3), pages 694-719, June.
    52. World Bank, 2020. "Global Economic Prospects, June 2020," World Bank Publications - Books, The World Bank Group, number 33748, December.
    53. Christophe Courbage & Béatrice Rey, 2012. "Priority setting in health care and higher order degree change in risk," Post-Print halshs-03353458, HAL.
    54. Russell Golman & David Hagmann & George Loewenstein, 2017. "Information Avoidance," Journal of Economic Literature, American Economic Association, vol. 55(1), pages 96-135, March.
    55. Luciana Echazu & Diego Nocetti, 2013. "Priority Setting In Health Care: Disentangling Risk Aversion From Inequality Aversion," Health Economics, John Wiley & Sons, Ltd., vol. 22(6), pages 730-740, June.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Anand, Vaibhav, 2001. "The Value of Forecast Improvements: Evidence from Advisory Lead Times and Vehicle Crashes," SocArXiv hdpga, Center for Open Science.
    2. Pablo Gutiérrez Cubillos & Roberto Pastén, 2023. "Nonlinear risks: a unified framework," Theory and Decision, Springer, vol. 95(1), pages 11-32, July.
    3. Heinzel Christoph & Richard Peter, 2021. "Precautionary motives with multiple instruments," Working Papers SMART 21-09, INRAE UMR SMART.
    4. Heinzel, Christoph & Peter, Richard, 2023. "Precaution with multiple instruments: The importance of substitution effects," Journal of Economic Behavior & Organization, Elsevier, vol. 207(C), pages 392-412.
    5. Heinzel, Christoph & Peter, Richard, 2021. "Precautionary motives with multiple instruments," Working Papers 316521, Institut National de la recherche Agronomique (INRA), Departement Sciences Sociales, Agriculture et Alimentation, Espace et Environnement (SAE2).
    6. Simon Sølvsten & Brooks Kaiser, 2023. "Do insurers adjust prices for the adoption of loss prevention technologies? Evidence from Danish municipal contracts," Risk Management and Insurance Review, American Risk and Insurance Association, vol. 26(1), pages 57-82, March.
    7. Anand, Vaibhav, 2022. "The Value of Forecast Improvements: Evidence from Advisory Lead Times and Vehicle Crashes," MPRA Paper 114491, University Library of Munich, Germany.
    8. Tobias Huber, 2022. "Comparative risk aversion in two periods: An application to self‐insurance and self‐protection," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 89(1), pages 97-130, March.
    9. Christoph Heinzel & Richard Peter, 2021. "Precautionary motives with multiple instruments [Motifs de précaution en cas de multiples instruments]," Working Papers hal-03484875, HAL.
    10. Claudio Bonilla & Marcos Vergara, 2022. "New results on precautionary saving and nonlinear risks," Journal of Economics, Springer, vol. 136(2), pages 177-189, July.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Peter, Richard & Ying, Jie, 2020. "Do you trust your insurer? Ambiguity about contract nonperformance and optimal insurance demand," Journal of Economic Behavior & Organization, Elsevier, vol. 180(C), pages 938-954.
    2. Elyès Jouini & Clotilde Napp & Diego Nocetti, 2013. "Economic consequences of Nth-degree risk increases and Nth-degree risk attitudes," Journal of Risk and Uncertainty, Springer, vol. 47(2), pages 199-224, October.
    3. Heinzel Christoph & Richard Peter, 2021. "Precautionary motives with multiple instruments," Working Papers SMART 21-09, INRAE UMR SMART.
    4. Christoph Heinzel & Richard Peter, 2021. "Precautionary motives with multiple instruments [Motifs de précaution en cas de multiples instruments]," Working Papers hal-03484875, HAL.
    5. Heinzel, Christoph & Peter, Richard, 2021. "Precautionary motives with multiple instruments," Working Papers 316521, Institut National de la recherche Agronomique (INRA), Departement Sciences Sociales, Agriculture et Alimentation, Espace et Environnement (SAE2).
    6. Christian Gollier & James Hammitt & Nicolas Treich, 2013. "Risk and choice: A research saga," Journal of Risk and Uncertainty, Springer, vol. 47(2), pages 129-145, October.
    7. Kubitza, Christian & Hofmann, Annette & Steinorth, Petra, 2019. "Financial literacy and precautionary insurance," ICIR Working Paper Series 34/19, Goethe University Frankfurt, International Center for Insurance Regulation (ICIR).
    8. Dionne, Georges & Harrington, Scott, 2017. "Insurance and Insurance Markets," Working Papers 17-2, HEC Montreal, Canada Research Chair in Risk Management.
    9. Chiu, W. Henry, 2019. "Comparative statics in an ordinal theory of choice under risk," Mathematical Social Sciences, Elsevier, vol. 101(C), pages 113-123.
    10. Tao Yuqing & Cheng Wen & Zou Sijie, 2018. "Priority Setting in Health Care with Disease and Treatment Risks," Journal of Systems Science and Information, De Gruyter, vol. 6(6), pages 552-562, December.
    11. Heinzel, Christoph & Peter, Richard, 2023. "Precaution with multiple instruments: The importance of substitution effects," Journal of Economic Behavior & Organization, Elsevier, vol. 207(C), pages 392-412.
    12. Peter, Richard, 2017. "Optimal self-protection in two periods: On the role of endogenous saving," Journal of Economic Behavior & Organization, Elsevier, vol. 137(C), pages 19-36.
    13. Johannes G. Jaspersen & Richard Peter & Marc A. Ragin, 2023. "Probability weighting and insurance demand in a unified framework," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 48(1), pages 63-109, March.
    14. Donatella Baiardi & Marco Magnani & Mario Menegatti, 2020. "The theory of precautionary saving: an overview of recent developments," Review of Economics of the Household, Springer, vol. 18(2), pages 513-542, June.
    15. Heinzel, Christoph, 2023. "Comparing utility derivative premia under additive and multiplicative risks," Insurance: Mathematics and Economics, Elsevier, vol. 111(C), pages 23-40.
    16. repec:dau:papers:123456789/11094 is not listed on IDEAS
    17. Marzia Donno & Marco Magnani & Mario Menegatti, 2020. "Changes in multiplicative risks and optimal portfolio choice: new interpretations and results," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 43(1), pages 251-267, June.
    18. Mario Menegatti & Richard Peter, 2022. "Changes in Risky Benefits and in Risky Costs: A Question of the Right Order," Management Science, INFORMS, vol. 68(5), pages 3625-3634, May.
    19. Kit Pong Wong, 2019. "An interpretation of the condition for precautionary saving: the case of greater higher-order interest rate risk," Journal of Economics, Springer, vol. 126(3), pages 275-286, April.
    20. Wang, Jianli & Wang, Hongxia & Yick, Ho Yin, 2019. "How do changes in risk and risk aversion affect self-protection with Selden/Kreps–Porteus preferences?," Insurance: Mathematics and Economics, Elsevier, vol. 88(C), pages 1-6.
    21. Pablo Gutiérrez Cubillos & Roberto Pastén, 2023. "Nonlinear risks: a unified framework," Theory and Decision, Springer, vol. 95(1), pages 11-32, July.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bla:jrinsu:v:88:y:2021:i:3:p:695-725. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Wiley Content Delivery (email available below). General contact details of provider: https://edirc.repec.org/data/ariaaea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.