The Potential for Underinvestment in Internet Security: Implications for Regulatory Policy

20 Pages Posted: 21 Mar 2006

See all articles by Alfredo Garcia

Alfredo Garcia

University of Virginia - Systems & Information Engineering

Barry Horowitz

University of Virginia - Systems Engineering

Abstract

With the continuing growth of the use of the Internet for business purposes, the consequences of a possible cyber attack that could create a large scale outage of long time duration becomes a more and more serious economic issue. In this paper, we construct a game-theoretic model that addresses the economic motivations for investment in added Internet security and makes a case for a possible market failure in the form of underinvestment in the provision of Internet security. This result relies on the fact that the social value derived from consumption (which is at least equal to a fraction of the surplus derived from e-commerce) greatly exceeds the revenue at stake associated with the telecommunications companies' and ISP's security levels. If the ratio of social value to revenue at stake to Internet providers continues to grow, the likelihood of underinvestment in security becomes higher and some form of regulation may become necessary. We discuss the difficulties associated with designing and enforcing a regulatory scheme based upon mandatory security standards.

Keywords: Internet Security, Market Failure, Game Theory, Nash Equilibrium, Markov Perfect Equilibrium

JEL Classification: L51, L86, C72, C73, K23

Suggested Citation

Garcia, Alfredo and Horowitz, Barry, The Potential for Underinvestment in Internet Security: Implications for Regulatory Policy. Journal of Regulatory Economics, Forthcoming, Available at SSRN: https://ssrn.com/abstract=889071

Alfredo Garcia (Contact Author)

University of Virginia - Systems & Information Engineering ( email )

1400 University Ave
Charlottesville, VA 22903
United States

Barry Horowitz

University of Virginia - Systems Engineering ( email )

Box 400246
Charlottesville, VA 22904-0246
United States

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