The Benefit-Cost Ratio as a Decision Criteria When Managing Catastrophes

Abstract

Previous work has shown that when projects are non-marginal, it creates an interdependence among projects. This implies that policies to manage catastrophes should not be evaluated in isolation but in conjunction with each other. As long as relative risk aversion is sufficiently high, the benefits of averting one catastrophe depend positively on the background risk created by other catastrophes. This specific bias makes it possible to create upper and lower boundaries on the willingness to pay to manage catastrophes and the optimal policy. These boundaries can be used to make inferences on which catastrophes should be averted and not, and in which order. The upper and lower boundaries depend only on the individual catastrophe’s benefit-cost ratio and the coefficient of risk aversion, which both are easy to identify using standard economic frameworks.