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Optimal risk regulation of monopolists with subjective risk assessment

Daiki Kishishita and Susumu Sato

Journal of Regulatory Economics, 2021, vol. 59, issue 3, No 3, 279 pages

Abstract: Abstract This study characterizes the optimal regulation of risky activities when the assessment of the probability of an accident is subjective. The optimism of stakeholders forms subjective risk perceptions, which substantially affect the optimal intervention. To explore this issue, we construct a moral hazard model with a limited liability constraint, where stakeholders have heterogeneous beliefs about the probability of an accident. First, we show that the optimism of a monopolist reduces the level of the preventive effort when regulatory instruments are fixed. We then analyze the case in which the regulator can set both a fine and a product price as regulatory instruments. The optimal product price increases with the monopolist’s degree of optimism, as the loose product market regulation encourages the preventive effort of the optimistic monopolist. Consequently, under such an optimal scheme, an increase in the optimism of the monopolist may increase the level of preventive effort.

Keywords: Monopoly regulation; Environmental risk; Ambiguity; Risk assessment; Moral hazard (search for similar items in EconPapers)
JEL-codes: D81 D82 L51 Q58 (search for similar items in EconPapers)
Date: 2021
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DOI: 10.1007/s11149-021-09429-0

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