The impact of ambiguity and prudence on prevention decisions
Most decisions concerning (self-)insurance and self-protection have to be taken in situations in which (a) the effort exerted precedes the moment uncertainty realizes, and (b) the probabilities of future states of the world are not perfectly known. By integrating these two characteristics in a simple theoretical framework, this paper derives plausible conditions under which ambiguity aversion raises the demand for (self-)insurance and self-protection. In particular, it is shown that in most usual situations where the level of ambiguity does not increase with the level of effort, a simple condition of ambiguity prudence known as decreasing absolute ambiguity aversion (DAAA) is sufficient to give a clear and positive answer to the question: Does ambiguity aversion raise the optimal level of effort?
KeywordsNon-expected utility Self-protection Self-insurance Ambiguity Prudence
JEL ClassificationD61 D81 D91 G11
The author thanks David Alary, Louis Eeckhoudt, Renaud Foucart, Christian Gollier, François Salanié, Nicolas Treich, and Philippe Weil for helpful comments and discussions. The research leading to this paper received funding from the FRS-FNRS and from the European Union Seventh Framework Programme FP7/2007-2013 under Grant agreement no. 308329 (ADVANCE).
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