Discussion Paper

No. 2015-65 | November 23, 2015
The Coming Breakthrough in Risk Research

Abstract

Rich countries have developed a historically unprecedented capability to manage conventional risks—fire, floods, earthquakes etc., but also car accidents, many workplace risks, and more. It is based on two institutions—insurance markets and public risk governance—supported by a powerful theory: the expected utility approach to risk. Expected utility refines the utilitarian paradigm of rational action by combining the concept of utility functions with the concept of probability distributions, using subjective probabilities where required. One might think that future progress in risk research will consist mainly in refining this approach and spreading it to emerging and less developed countries. However, greater progress is necessary and possible. It is necessary because the global economy and technostructure we live in have generated new systemic risks—including financial crises, pandemics, climate change, nuclear war. These risks exceed the coping capacity of conventional risk management and call for new forms of integrated risk governance. Greater progress is possible because recent research has developed ways to address the basic difficulties of expected utility without loosing its valuable insights. They involve three major advances. First, to introduce a risk function that generalizes expected utility so as to overcome well-known difficulties like the Allais paradox. Second, to embed expected utility in a framework of iterated network games so as to take into account the social learning processes that are essential for real world risk governance. And third, to accommodate the logic of complementary descriptions called for by the new systemic risks of the 21st century. The coming breakthrough in risk research may best be achieved by bringing these advances to bear on practical efforts aiming at integrated risk governance.

JEL Classification:

B41, C73, D80

Assessment

  • Downloads: 921

Links

Cite As

Carlo Jaeger (2015). The Coming Breakthrough in Risk Research. Economics Discussion Papers, No 2015-65, Kiel Institute for the World Economy. http://www.economics-ejournal.org/economics/discussionpapers/2015-65


Comments and Questions


Anonymous - Carlo Jaeger
November 24, 2015 - 09:40

The opening lines of Mr Jaeger’s essay on natural disasters over the world are cavalier bordering on cruel. They are also contradictory. While extolling developed countries for their expertise in designing technologies to mitigate the effects of these disasters, he reports that the worst of Katrina and Tohoku would have ...[more]

... been averted had these mechanisms been deployed. The distinction between developed and developing is Western rationality, the latter characterised by self-interest. However, self-interest it is what comes in the way of addressing massive negative externalities. It is precisely communitarian endeavours, for which developing countries are not less well known, that rebuild societies (Later, the author claims that adding subscripts to a utility function (2) transforms it into a network).
The rest of the paper is old hat but presented in a disjointed and opaque manner. He veers wildly into everything under the sun and I had to scroll upwards to the title more than once!


Carlo Jaeger - Opening lines
November 25, 2015 - 09:16

The opening lines of my paper on risk research have upset an anonymous reader to the point of letting him write a rather contemptuous comment. I respond by flagging two important points in that comment.


Armin Haas - An innovative system science approach
December 08, 2015 - 19:09

It should be straightforward that when one ventures into tackling systemic risks, one should also apply a systems science approach. Unfortunately, we cannot take that for granted. Recently, I looked into the contemporary literature on systemic risks, and was surprised to find many communities apply their non-systemic tools for analyzing ...[more]

... systemic risks. When I thought twice, I saw the logic of it: The financial crises had driven up demand for new approaches, and many communities used their tools at hand for meeting this demand – irrespective of whether these tools were suited for this task, or not.

Of course there are communities that use a systems science approach for tackling systemic risks. I personally like the approach of complex networks. Nevertheless, it is an open question to me whether the tools and approaches available are sufficiently powerful for meeting the challenge. I think I will not end up as a maverick when I confess that I doubt that our current toolbox is up to the task. Rather I think that we need new tools, and powerful ones.

Carlo Jaeger suggests combining three specific tools in order to create an innovative approach. He wants to combine a generalization of the well-known expected utility approach; iterated games with transition functions; and a specific generalization of logic. Each of these tools are more or less established, and the author does not claim to have invented them. The innovation lies in combining these three tools. I would not know of another paper that advocates this specific combination, but would welcome if the anonymous colleague who judged Jaeger’s paper to contain old hats could point me to respective hat boxes.

Whether one likes this new hat is another issue. Many colleagues prefer to stick to their tool of choice with which they feel familiar and which had been the basis of their own career within their specific community. Creating something new in the intersection of established communities typically is a challenge. Jaeger aims at the intersection of expected utility theorists, iterated games experts, and logicians. Quite a challenge, indeed, but a challenge that could be worthwhile – given what is at stake.


Anonymous - Referee Report 1
January 04, 2016 - 11:27

I read with great interest the paper THE COMING BREAKTHROUGH IN RISK RESEARCH
by Carlo Jaeger.
It is a nice, easy-to-read yet informative and rigorous description of the study of risk.
I am definitely in favour of publication, but I would ask the author to consider these optional comments to ...[more]

... his work.
1) When dealing with uncertainty, (as far as I understood) the only source of uncertainty for a rational agent is the stochasticity of the phenomena observed. Yet there is also another source that is that of incomplete information. Could the author comment on that?
2) The example on page 9, can also be explained by making use of conditioned probability, in any case it is worth noticing that the basic mechanism of extraction with replacement is another way to produce multiplicative noise, that in various forms (De Solla Price, AB models) is at the basis of some of the log-normal/power-laws distributions observed.
3) Does the form of the random shock (\xi) play any role in the derivation of solution for iterated games?
4) in the application to climate change a third source of uncertainty is given by the error in measurement of the quantity of interest. How to deal to compute correctly the risk with this third source of uncertainty?


Anonymous - Referee Report 2
March 07, 2016 - 09:39

see attached file


Carlo Jaeger - Response to Reviewers
May 06, 2016 - 11:10

see attached file


Carlo Jaeger - Revised Version
May 06, 2016 - 11:19

see attached file