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The Value of Risk Reduction: New Tools for an Old Problem

  • David Crainich

    (CNRS-LEM and IESEG School of Management)

  • Louis Eeckhoudt

    (IESEG School of Management (LEM-CNRS) and and CORE (Université Catholique de Louvain))

  • James K. Hammitt


    (Harvard University (Center for Risk Analysis), Cambridge - Toulouse School of Economics (LERNA-INRA))

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 concepts of prudence (equivalently, downside risk aversion), 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.

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Paper provided by IESEG School of Management in its series Working Papers with number 2013-ECO-13.

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Length: 12 pages
Date of creation: Jun 2013
Date of revision:
Handle: RePEc:ies:wpaper:e201313
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