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The value of risk reduction: new tools for an old problem

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  • David Crainich
  • Louis Eeckhoudt
  • James Hammitt

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Abstract

The 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 the concept of downside risk aversion or prudence, 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. Copyright Springer Science+Business Media New York 2015

Suggested Citation

  • David Crainich & Louis Eeckhoudt & James Hammitt, 2015. "The value of risk reduction: new tools for an old problem," Theory and Decision, Springer, vol. 79(3), pages 403-413, November.
  • Handle: RePEc:kap:theord:v:79:y:2015:i:3:p:403-413
    DOI: 10.1007/s11238-014-9475-7
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    References listed on IDEAS

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    1. repec:kap:jrisku:v:55:y:2017:i:1:d:10.1007_s11166-017-9265-z is not listed on IDEAS
    2. 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.

    More about this item

    Keywords

    Risk aversion; Prudence; Self-protection; Value per statistical life; D8; I1;

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • I1 - Health, Education, and Welfare - - Health

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