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Collective Risk Control and Group Security: The Unexpected Consequences of Differential Risk Aversion

Collective Risk Control and Group Security: The Unexpected Consequences of Differential Risk... We provide an analysis of odds‐improving self‐protection for when it yields collective benefits to groups, such as alliances of nations, for whom risks of loss are public bads and prevention of loss is a public good. Our analysis of common risk reduction shows how diminishing returns in risk improvement can be folded into income effects. These income effects then imply that whether protection is inferior or normal depends on the risk aversion characteristics of underlying utility functions, and on the interaction between these, the level of risk, and marginal effectiveness of risk abatement. We demonstrate how public good inferiority is highly likely when the good is “group risk reduction.” In fact, we discover a natural or endogenous limit on the size of a group and of the amount of risk controlling outlay it will provide under Nash behavior. We call this limit an “Inferior Goods Barrier” to voluntary risk reduction. For the paradigm case of declining risk aversion, increases in group size(wealth) will cause provision of more safety to change from a normal to an inferior good thereby creating such a barrier. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Journal of Public Economic Theory Wiley

Collective Risk Control and Group Security: The Unexpected Consequences of Differential Risk Aversion

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References (37)

Publisher
Wiley
Copyright
Copyright © 2007 Wiley Subscription Services, Inc., A Wiley Company
ISSN
1097-3923
eISSN
1467-9779
DOI
10.1111/j.1467-9779.2007.00306.x
Publisher site
See Article on Publisher Site

Abstract

We provide an analysis of odds‐improving self‐protection for when it yields collective benefits to groups, such as alliances of nations, for whom risks of loss are public bads and prevention of loss is a public good. Our analysis of common risk reduction shows how diminishing returns in risk improvement can be folded into income effects. These income effects then imply that whether protection is inferior or normal depends on the risk aversion characteristics of underlying utility functions, and on the interaction between these, the level of risk, and marginal effectiveness of risk abatement. We demonstrate how public good inferiority is highly likely when the good is “group risk reduction.” In fact, we discover a natural or endogenous limit on the size of a group and of the amount of risk controlling outlay it will provide under Nash behavior. We call this limit an “Inferior Goods Barrier” to voluntary risk reduction. For the paradigm case of declining risk aversion, increases in group size(wealth) will cause provision of more safety to change from a normal to an inferior good thereby creating such a barrier.

Journal

Journal of Public Economic Theory – Wiley

Published: Apr 1, 2007

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