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Should we do more when we know less? The effect of technology risk on optimal effort

Lu Li and Richard Peter

Journal of Risk & Insurance, 2021, vol. 88, issue 3, 695-725

Abstract: 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.

Date: 2021
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https://doi.org/10.1111/jori.12339

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