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The Elasticity of a Random Variable as a Tool for Measuring and Assessing Risks

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  • Ernesto-Jesús Veres-Ferrer

    (Quantitative Methods Area, Department of Applied Economics, Universitat de Valencia, 46022 Valencia, Spain)

  • Jose M. Pavía

    (Quantitative Methods Area, Department of Applied Economics, Universitat de Valencia, 46022 Valencia, Spain)

Abstract

Elasticity is a very popular concept in economics and physics, recently exported and reinterpreted in the statistical field, where it has given form to the so-called elasticity function. This function has proved to be a very useful tool for quantifying and evaluating risks, with applications in disciplines as varied as public health and financial risk management. In this study, we consider the elasticity function in random terms, defining its probability distribution, which allows us to measure for each stochastic process the probability of finding elastic or inelastic situations (i.e., with elasticities greater or less than 1). This new tool, together with new results on the most notable points of the elasticity function covered in this research, offers a new approach to risk assessment, facilitating proactive risk management. The paper also includes other contributions of interest, such as new results that relate elasticity and inverse hazard functions, the derivation of the functional form of the cumulative distribution function of a probability model with constant elasticity and how the elasticities of functionally dependent variables are related. The interested reader can also find in the paper examples of how elasticity cumulative distribution functions are calculated, and an extensive list of probability models with their associated elasticity functions and distributions.

Suggested Citation

  • Ernesto-Jesús Veres-Ferrer & Jose M. Pavía, 2022. "The Elasticity of a Random Variable as a Tool for Measuring and Assessing Risks," Risks, MDPI, vol. 10(3), pages 1-38, March.
    • Handle: RePEc:gam:jrisks:v:10:y:2022:i:3:p:68-:d:774703
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    References listed on IDEAS

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