ENDOGENOUS RISK AND PROTECTION PREMIUMS

Endogenous risk implies an individual perceives he can influence the likelihood that a state of nature will occur. To add structure to endogenous risk models, I define a protection premium for reduced uncertainty about protection efficiency when a stochastic variable enters the probability function p(x) rather than the utility function. For a binary lottery, a measure of aversion of uncertain protection efficiency Γ(x) =-p″(x)/p′(x) is defined to unambiguously determine the effects of increased risk on an individual's voluntary contribution to public good supply earmarked to reduce the probability of an undesirable state. Finally, I examine the protection premium in an n-state discrete lottery and when uncertainty exists in both the probability and utility function. © 1991 Kluwer Academic Publishers.