Expected Utility Theory and the Tyranny of Catastrophic Risks

19 Pages Posted: 11 Sep 2010

See all articles by Wolfgang Buchholz

Wolfgang Buchholz

Universitaet Regensburg; CESifo (Center for Economic Studies and Ifo Institute)

Michael Schymura

ZEW – Leibniz Centre for European Economic Research

Date Written: 2010

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 a ffect 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.

Keywords: Utilitarianism, Expected Utility Theory, Catastrophic Risks

JEL Classification: Q54

Suggested Citation

Buchholz, Wolfgang and Schymura, Michael, Expected Utility Theory and the Tyranny of Catastrophic Risks (2010). ZEW - Centre for European Economic Research Discussion Paper No. 10-059, Available at SSRN: https://ssrn.com/abstract=1674853 or http://dx.doi.org/10.2139/ssrn.1674853

Wolfgang Buchholz

Universitaet Regensburg ( email )

D-93040 Regensburg, 93053
Germany

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Michael Schymura (Contact Author)

ZEW – Leibniz Centre for European Economic Research ( email )

P.O. Box 10 34 43
L 7,1
D-68034 Mannheim, 68034
Germany

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