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Risk aversion as risk-neutral pessimism: A simple proof

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  • Heaton, J.B.

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.

Suggested Citation

  • Heaton, J.B., 2018. "Risk aversion as risk-neutral pessimism: A simple proof," International Review of Law and Economics, Elsevier, vol. 56(C), pages 70-72.
    • Handle: RePEc:eee:irlaec:v:56:y:2018:i:c:p:70-72
    DOI: 10.1016/j.irle.2018.07.002
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    References listed on IDEAS

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    Cited by:

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    2. Hylton, Keith N., 2023. "Mutual optimism and risk preferences in litigation," International Review of Law and Economics, Elsevier, vol. 75(C).

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    More about this item

    Keywords

    Economic analysis of litigation; Risk aversion; Risk neutral probabilities; Pessimism; Criminal law; Plea bargains; Settlement;
    All these keywords.

    JEL classification:

    • C65 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Miscellaneous Mathematical Tools
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • K14 - Law and Economics - - Basic Areas of Law - - - Criminal Law
    • K15 - Law and Economics - - Basic Areas of Law - - - Civil Law; Common Law
    • K41 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior - - - Litigation Process

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