Should We Do More When We Know Less?: Optimal Risk Mitigation Under Technological Uncertainty
50 Pages Posted: 31 Aug 2018 Last revised: 25 May 2019
Date Written: May 22, 2019
Most risk mitigation activities involve technological uncertainty (TU) because their effectiveness depends on exogenous factors beyond the decision-maker's control or due to the decision-maker's incomplete knowledge about the associated benefits. We provide a systematic assessment of the effects of TU on self-insurance and self-protection decisions. TU affects the optimal level of risk mitigation via two channels: a preference channel and a technology channel. We identify conditions that yield unambiguous comparative statics of TU at the extensive margin, for FSD improvements and at the intensive margin. These conditions involve prudence, relative risk aversion and relative prudence as well as several new measures of technological efficacy. We highlight cases where TU raises the optimal level of risk mitigation, consistent with the precautionary principle. Our theory has implications in various fields of application, which we demonstrate via selected topics in preventive healthcare, insurance demand and climate change.
Keywords: Self-Insurance, Self-Protection, Risk Aversion, Prudence, Technological Uncertainty
JEL Classification: D61, D81, D91, G22
Suggested Citation: Suggested Citation