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Should we do more when we know less? The effect of technology risk on optimal effort
Author(s) -
Li Lu,
Peter Richard
Publication year - 2021
Publication title -
journal of risk and insurance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.055
H-Index - 63
eISSN - 1539-6975
pISSN - 0022-4367
DOI - 10.1111/jori.12339
Subject(s) - prudence , comparative statics , preference , risk aversion (psychology) , economics , risk analysis (engineering) , channel (broadcasting) , actuarial science , microeconomics , expected utility hypothesis , business , computer science , financial economics , computer network , philosophy , theology
Technology risk arises when the effectiveness of self‐insurance and self‐protection activities depends on exogenous factors or is only imperfectly known. It affects optimal behavior via a preference channel and a technology channel. In this paper, we identify conditions for unambiguous comparative statics with respect to the presence of, as well as various stochastic changes in technology risk. These conditions involve prudence, relative risk aversion, relative prudence, and several new measures of mitigation efficacy. We highlight cases where technology risk raises the optimal level of effort, consistent with the precautionary principle. We discuss several applications of our results.