Risk Analysis in Theory and Practice
Presenting a mix of conceptual analyses and applied problems, this book provides useful insights into the economic rationality of decision-making under uncertainty.
TABLE OF CONTENTS Risk Analysis in Theory and Practice
THE ROLE OF UNCERTAINTY
As discussed in Chapters 4 and 10, risk can affect individual welfare in two ways: (1) because of the implicit cost of risk under risk aversion, and (2) because of information under learning. We show below that similar arguments apply to the efficiency evaluation of risk.
RISK AVERSION
In Chapter 4, we defined the implicit cost of private risk bearing by the Arrow Pratt risk premium. Although the analysis was presented using the expected utility model, we explore briefly how to extend it in the context of state-dependent preferences. The uncertainty is represented by the states e = ( e 1, , e s). Let the i-th individual have preferences represented by the ex-ante utility function u i( z e), where z e = ( z 1( e 1), , z 1( e s); z 2( e 1), , z 2( e s); ), z k( e s) being the k-th decision made under state e s. Assume that the i-th individual assesses the uncertainty through a subjective probability distribution of the states: Pr( e 1, i), , Pr( e s, i). Consider the state-independent commodities E i( z e) = ( E i( z 1( e)), , E i( z 1( e)); E i( z
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