Perception of Risk Posed by Extreme Events

1
Perception of Risk Posed by Extreme Events

• Risk Management Strategies in an Uncertain World
• Kim B. Staking

2
Risk Analysis

• Risk Assessment
• Risk Management
• Politics of Risk
• Preferences for risk decision alternatives are
  associated with differences in the perception of
  the relative risk of choice options rather than
  attitudes towards risk (avoid options perceived
  as riskier)

3
Nature of Risk

• Scientific/technical/economic approach
• Risk is Objectively quantified (quantifiable)
• by risk assessment
• Social science approach
• Risk is seen as inherently subjective
• (risk invented to help understand/cope
• with dangers and uncertainties of life)
• Can these approaches be reconciled?

4
Risk PerceptionsPsychometric Paradigm

• Quantitative (normative) judgments on riskiness
  and desired regulation
• Perceived risk is quantifiable and predictable
  (orderly and complex)
• Factors
• Dread Risk
• Unknown Risk
• Number of People exposed (in some studies)

5
Social Amplification of Risk

• Amplification triggered by occurrence of adverse
  event (extreme event)
• Adverse impact may extend far beyond direct
  damage (litigation, loss of sales, increased
  regulation)
• Adverse impact may extend beyond responsible party

6
Human Processing of Risk

• Evolutionary (instinct)
• Similarity and association
• Hard-wired
• Early warning system
• Rational
• Algorithms and rules
• Slow (not hard-wired) need to learn rules
• Two rules work in parallel
• often result in same decision
• When systems disagree, evolutionary usually
  prevails
• Rare events tend to over-weighted

7
Movement towards rationality

• Better information
• Relate to problems at hand
• Improve reliability of information
• Increase trust in information
• Develop associations
• Own experience
• Experiences of others

8
Insurance Implications

• What impact does the price of risk have on
  perception or risk?
• How does the insurance industry communicate
  knowledge of risk?
• What happens to insurance markets When risk
  changes unexpectedly?
• Change in judicial liability
• Probability of Terror event

9
Emerging Market Examples

• Mortgage markets in Colombia and constitutional
  court
• Direct impact Capital Loss
• Indirect impact Higher cost of capital loss of
  investment
• Collateral Arrangements in Latin America
• Direct impact higher risk ? increased interest
  rate
• Indirect impact exclusion of some borrowers
  slower decision making process

10
Suggestions for Empirical Testing

• Look at insurance markets when information is in
  flux.
• Attempt to replicate the analysis in other
  countries (look at behavior in emerging markets
  where exposure to extreme risk is more common.