You Only Die Once: Managing Discrete Interdependent Risks

Abstract

This paper extends our earlier analysis of interdependent security issues to a general class of problems involving discrete interdependent risks with heterogeneous agents. There is a threat of an event that can only happen once, and the risk this poses to any one agent depends on actions taken by others. Thus any agent's incentive to invest in managing the risk also depends on the actions of others. Security problems at airlines and in computer networks come into this category, as do problems of risk management in organizations facing the possibility of bankruptcy, and individuals' choices about whether to be vaccinated against an infectious disease. Surprisingly the framework also covers certain aspects of investment in R&D. Here we characterize Nash equilibria with heterogeneous agents and give conditions for tipping and cascading of equilibria.

Keywords: Nash equilibrium, tipping, cascading, terrorism, security, interdependence

JEL Classification: C72, D80, H23