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Uncertainty, Risk Aversion, And Optimal Defense Against Interruptions In Supply

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  • Martin McGuire

Abstract

Recent international conflicts have resurrected concerns about how to manage supply disruptions or sudden escalation of need for energy, and other critical imports such as vaccines or military components. Prominent proactive measures include support of domestic production and accumulation of reserves or maintenance of stand-by production. This paper develops a clear transparent method for comparing instruments and for identifying the optimum policy mix. We show how a country's risk aversion influences the best mix of policies and interacts unexpectedly with the degree of risk itself. Specifically, high-risk aversion and low risk are shown to favor domestic production support as the better defense, and to disfavor stockpiling (and vice versa). In clarifying a country's best policy response to risks of supply interruption, this analysis predicts how income level and risk aversion characteristics should shape arguments for and against interference with free trade on grounds of 'national security.'

Suggested Citation

  • Martin McGuire, 2006. "Uncertainty, Risk Aversion, And Optimal Defense Against Interruptions In Supply," Defence and Peace Economics, Taylor & Francis Journals, vol. 17(4), pages 287-309.
  • Handle: RePEc:taf:defpea:v:17:y:2006:i:4:p:287-309
    DOI: 10.1080/10242690600612688
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    References listed on IDEAS

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    1. Williams,Jeffrey C. & Wright,Brian D., 2005. "Storage and Commodity Markets," Cambridge Books, Cambridge University Press, number 9780521023399, May.
    2. Ehrlich, Isaac & Becker, Gary S, 1972. "Market Insurance, Self-Insurance, and Self-Protection," Journal of Political Economy, University of Chicago Press, vol. 80(4), pages 623-648, July-Aug..
    3. McGuire, M., 2000. "Provision for Adversity: Managing Supply Uncertainties in an Era of Globalization," Papers 99-00-16, California Irvine - School of Social Sciences.
    4. McGuire, Martin C & Pratt, John & Zeckhauser, Richard, 1991. "Paying to Improve Your Chances: Gambling or Insurance?," Journal of Risk and Uncertainty, Springer, vol. 4(4), pages 329-338, December.
    5. Toshihiro Ihori, 1999. "Protection against national emergency: International public goods and insurance," Defence and Peace Economics, Taylor & Francis Journals, vol. 10(2), pages 117-137.
    6. Todd Sandler & HÃ¥vard Hegre, 2002. "Economic analysis of civil wars," Defence and Peace Economics, Taylor & Francis Journals, vol. 13(6), pages 429-433.
    7. Sandler,Todd & Hartley,Keith, 1995. "The Economics of Defense," Cambridge Books, Cambridge University Press, number 9780521447287, May.
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    Cited by:

    1. Toshihiro Ihori & Martin McGuireb, 2008. "National Adversity: Managing Insurance and Protection," CIRJE F-Series CIRJE-F-554, CIRJE, Faculty of Economics, University of Tokyo.
    2. 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.
    3. Toshihiro Ihori & Martin McGuire, 2006. "Group Provision Against Adversity: Security By Insurance vs. Protection," CARF F-Series CARF-F-086, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.

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