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Expected Utility theory and the tyranny of catastrophic risks

Author

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  • Buchholz, Wolfgang
  • Schymura, Michael
Abstract
Expected Utility theory is not only applied to individual choices but also to ethical decisions, e.g. in cost-benefit analysis of climate change policy measures that affect future generations. In this context the crucial question arises whether EU theory is able to deal with 'catastrophic risks', i.e. risks of high, but very unlikely losses, in an ethically appealing way. In this paper we show that this is not the case. Rather, if in the framework of EU theory a plausible level of risk aversion is assumed, a 'tyranny of catastrophic risk' (TCR) emerges, i.e. project evaluation may be dominated by the catastrophic event even if its probability is negligibly small. With low degrees of risk aversion, however the catastrophic risk eventually has no impact at all when its probability goes to zero which is ethically not acceptable as well.

Suggested Citation

  • Buchholz, Wolfgang & Schymura, Michael, 2010. "Expected Utility theory and the tyranny of catastrophic risks," ZEW Discussion Papers 10-059, ZEW - Leibniz Centre for European Economic Research.
    • Handle: RePEc:zbw:zewdip:10059
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    Cited by:

    1. Chanel, Olivier & Chichilnisky, Graciela, 2013. "Valuing life: Experimental evidence using sensitivity to rare events," Ecological Economics, Elsevier, vol. 85(C), pages 198-205.
    2. Johannes Emmerling, 2015. "Uncertainty and Natural Resources - Prudence Facing Doomsday," Working Papers 2015.49, Fondazione Eni Enrico Mattei.
    3. Edilio Valentini & Paolo Vitale, 2019. "Optimal Climate Policy for a Pessimistic Social Planner," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 72(2), pages 411-443, February.
    4. Liu, Shuang & Aurambout, Jean-Philippe & Villalta, Oscar & Edwards, Jacqueline & De Barro, Paul & Kriticos, Darren J. & Cook, David C., 2015. "A structured war-gaming framework for managing extreme risks," Ecological Economics, Elsevier, vol. 116(C), pages 369-377.
    5. Buchholz Wolfgang & Heindl Peter, 2015. "Ökonomische Herausforderungen des Klimawandels," Perspektiven der Wirtschaftspolitik, De Gruyter, vol. 16(4), pages 324-350, December.
    6. Michielsen, T.O., 2013. "Environmental Catastrophes Under Time-inconsistent Preferences," Other publications TiSEM 921f1ff7-67c9-45bc-968d-7, Tilburg University, School of Economics and Management.
    7. Ikefuji, Masako & Laeven, Roger J.A. & Magnus, Jan R. & Muris, Chris, 2020. "Expected utility and catastrophic risk in a stochastic economy–climate model," Journal of Econometrics, Elsevier, vol. 214(1), pages 110-129.
    8. Vale, Petterson Molina, 2016. "The changing climate of climate change economics," Ecological Economics, Elsevier, vol. 121(C), pages 12-19.
    9. Frank Ackerman & Elizabeth Stanton & Ramón Bueno, 2013. "Epstein–Zin Utility in DICE: Is Risk Aversion Irrelevant to Climate Policy?," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 56(1), pages 73-84, September.
    10. Ikefuji, Masako & Laeven, Roger J.A. & Magnus, Jan R. & Muris, Chris, 2015. "Expected utility and catastrophic consumption risk," Insurance: Mathematics and Economics, Elsevier, vol. 64(C), pages 306-312.
    11. Michielsen, T.O., 2013. "Environmental Catastrophes Under Time-inconsistent Preferences," Discussion Paper 2013-013, Tilburg University, Center for Economic Research.
    12. Thomas Michielsen, 2013. "Environmental Catastrophes under Time-Inconsistent Preferences," Working Papers 2013.55, Fondazione Eni Enrico Mattei.
    13. Grechuk, Bogdan & Zabarankin, Michael, 2014. "Risk averse decision making under catastrophic risk," European Journal of Operational Research, Elsevier, vol. 239(1), pages 166-176.
    14. Owen Cotton‐Barratt & Max Daniel & Anders Sandberg, 2020. "Defence in Depth Against Human Extinction: Prevention, Response, Resilience, and Why They All Matter," Global Policy, London School of Economics and Political Science, vol. 11(3), pages 271-282, May.
    15. Masako Ikefuji & Roger Laeven & Jan Magnus & Chris Muris, 2014. "Expected Utility and Catastrophic Risk," Tinbergen Institute Discussion Papers 14-133/III, Tinbergen Institute.

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    More about this item

    Keywords

    utilitarianism; Expected Utility theory; catastrophic risks;
    All these keywords.

    JEL classification:

    • Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters and their Management; Global Warming

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