Essays on risk and insurance with endogenous hazards

Fraser, Clive Dilworth (1983) Essays on risk and insurance with endogenous hazards. University of Southampton, Doctoral Thesis.

Abstract

This thesis uses a series of simple, specific but inter-related, models to examine issues in the economics of risk and insurance with endogenous hazards. We analyse specific models because of well-known difficulties in the economics of risk with multiple decision variables which arise from possible non-convexities and interactions between the controls.Following Chapter 1, the Introduction and Summary, the principal part of the thesis, Chapters 2-4, analyses a simple two-states, single-period, principal-agent type problem. Risks confronted by one party (the principal) are physical; his preferences, at least, are state-dependent. A large number of interesting economic environments involving bilateral risk-sharing can be imbedded in this canonical framework, including the following. In Chapter 2 we consider optimal compensation for potential fatality - the Value of Life - and compare the consequences of certain and conditional compensation for, inter alia, endogenous and asymmetrically-held risk assessments. The compensator (the agent) is assumed risk-neutral. Chapter 3 considers a risk-averse compensator. Principal concern here is how variations in his conditional (or unconditionnal) risk aversion affects Pareto -efficient financial risk-sharing and the level of physical risk. Chapter 4 specializes Chapter 2's risk neutral compensator model to consider compensating wage differentials for occupational hazards. Two broad issues are discussed. In §4.1, a model of adaptive worker behaviour is used to discuss whether worker learning affects the conclusion, from Chapter 2's static model, that the risk assessments of compensator and compensatee might be inversely related. In §4.2, potential workers are distinguished by two attributes: skill (human capital) and financial capital. We suggest that because equivalent variations in each affect a worker's reservation wage (including desired job attributes - e.g., safety) identically, while labour demand depends only upon his skill, there might be discontinuities in the relationship between the riskiness of the occupations to which workers are allocated and their financial or human capital. The endogenous hazards in Chapters 2-4 principally relate to 'environmental quality'. Chapter 5, finally, considers the pricing and quality control strategy of a monopoly producer. The risk confronted arises from future goodwill loss reflected in the market exit of dissatisfied customers.

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