The Impact of Prudence on Optimal Prevention Revisited
Lingnan University - Department of Finance and Insurance
HEC Montreal - Department of Finance
August 31, 2010
This paper re-examines the link between absolute prudence and self-protection activities. We show that the level of effort chosen by an agent with positive and decreasing absolute prudence is larger than the optimal effort chosen by a risk-neutral agent if the degree of absolute prudence is less than a threshold that is utility-independent and empirically verifiable.
We explain this threshold by a trade-off between the variation of the variance and the level of the third moment of the loss distribution. We also discuss our result in terms of skewness. Our contribution extends the model of Eeckhoudt and Gollier (2005).
Number of Pages in PDF File: 14
Keywords: Absolute prudence, Moments of the loss distribution, Self-protection, Variance, Skewness
JEL Classification: D61, D81.working papers series
Date posted: July 15, 2010 ; Last revised: September 9, 2010
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