The impact of temporal utility evaluation and changes of loss distribution on optimal prevention

Abstract

Prevention or Self-Protection is an activity that reduces the probability of the occurrence of an hazardous event. However, it comes at a cost, either because of money or free time one has to spent. Thus, the question arises of an optimal level of prevention an agent should exert, with respect to his level of prudence. In the previous literature it was shown that it is important to distinguish in the modelling the time point, when prevention activity is spent, with the time of its effects. This new temporal dimension in the prevention problem calls for a correct evaluation of the issue at the time, when the activity is spent, as the agent decides the level of prevention then. It follows, that the second time period needs to be moved in time and has to be re-evaluated at the first time point. Furthermore, most models of optimal prevention consider only two states of the world, at the time of the hazardous event. One in which the event occurs and one where it does not. However, it seems more realistic to consider a more general situation, where the agent can also suffer only parts of the maximal loss.\\ To sum up, this thesis tries to analyse differences in the optimal level of prevention with reference to increased prudence. Furthermore, it will do so by taking into account two main issues. First, the necessity of proper utility evaluation at the time point of decision and its impact on the optimal level. And second, the effect of a more generally distributed loss.