Risk Aversion as Risk-Neutral Pessimism: A Simple Proof
Posted: 29 May 2018 Last revised: 22 Nov 2020
Date Written: July 16, 2018
It has long been understood that risk aversion reduces the likelihood of suit. This article offers a simple proof that risk aversion is observationally equivalent to risk-neutral pessimism by applying a change of measure to risk-neutral probabilities. The observational equivalence of risk aversion to risk-neutral pessimism may provide a useful framework for proving results in the study of several areas of interest, including (1) the role of risk-transfer mechanisms like contingency fees and litigation funding; (2) calls for prohibitions on, or judicial participation in, plea bargains; and (3) broader judicial review of the fairness, reasonableness, and adequacy of settlements in individual (that is, non-class) civil actions.
Keywords: Economic Analysis of Litigation, Risk Aversion, Risk Neutral Probabilities, Pessimism, Criminal Law, Plea Bargains, Settlement
JEL Classification: C65, D84, D91, K14, K15, K41
Suggested Citation: Suggested Citation