Risk Aversion as Risk-Neutral Pessimism: A Simple Proof

Posted: 29 May 2018 Last revised: 22 Nov 2020

Date Written: July 16, 2018

Abstract

It has long been understood that risk aversion reduces the likelihood of suit. This article offers a simple proof that risk aversion is observationally equivalent to risk-neutral pessimism by applying a change of measure to risk-neutral probabilities. The observational equivalence of risk aversion to risk-neutral pessimism may provide a useful framework for proving results in the study of several areas of interest, including (1) the role of risk-transfer mechanisms like contingency fees and litigation funding; (2) calls for prohibitions on, or judicial participation in, plea bargains; and (3) broader judicial review of the fairness, reasonableness, and adequacy of settlements in individual (that is, non-class) civil actions.

Keywords: Economic Analysis of Litigation, Risk Aversion, Risk Neutral Probabilities, Pessimism, Criminal Law, Plea Bargains, Settlement

JEL Classification: C65, D84, D91, K14, K15, K41

Suggested Citation

Heaton, J.B., Risk Aversion as Risk-Neutral Pessimism: A Simple Proof (July 16, 2018). International Review of Law and Economics, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3179835 or http://dx.doi.org/10.2139/ssrn.3179835

J.B. Heaton (Contact Author)

One Hat Research LLC ( email )

Chicago, IL
United States
(312) 257-3900 (Phone)

HOME PAGE: http://www.onehatr.com/

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