Risk averse decision making under catastrophic risk

Bogdan Grechuk and Michael Zabarankin

European Journal of Operational Research, 2014, vol. 239, issue 1, 166-176

Abstract: A nonstandard probabilistic setting for modeling of the risk of catastrophic events is presented. It allows random variables to take on infinitely large negative values with non-zero probability, which correspond to catastrophic consequences unmeasurable in monetary terms, e.g. loss of human lives. Thanks to this extension, the safety-first principle is proved to be consistent with traditional axioms on a preference relation, such as monotonicity, continuity, and risk aversion. Also, a robust preference relation is introduced, and an example of a monotone robust preference relation, sensitive to catastrophic events in the sense of Chichilnisky (2002), is provided. The suggested setting is demonstrated in evaluating nuclear power plant projects when the probability of a catastrophe is itself a random variable.

Keywords: Decision making; Catastrophic risk; Safety-first principle; Risk aversion; Nuclear power plant (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (5)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ejores:v:239:y:2014:i:1:p:166-176

DOI: 10.1016/j.ejor.2014.04.042

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