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

See all articles by Lu Li

Lu Li

Ludwig-Maximilians-University of Munich - Faculty of Business Administration (Munich School of Management)

Richard Peter

University of Iowa

Date Written: May 22, 2019

Abstract

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

Li, Lu and Peter, Richard, Should We Do More When We Know Less?: Optimal Risk Mitigation Under Technological Uncertainty (May 22, 2019). Available at SSRN: https://ssrn.com/abstract=3236841 or http://dx.doi.org/10.2139/ssrn.3236841

Lu Li (Contact Author)

Ludwig-Maximilians-University of Munich - Faculty of Business Administration (Munich School of Management) ( email )

Schackstr. 4
Munich
Germany

Richard Peter

University of Iowa ( email )

341 Schaeffer Hall
Iowa City, IA 52242-1097
United States

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