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Risk Analysis for Extreme Events: Economic Incentives for Reducing Future Losses.


pdf icon Risk Analysis for Extreme Events: Economic Incentives for Reducing Future Losses. (510 K)
Kunreuther, H.; Meyer, R.; VandenBulte, C.

NIST GCR 04-871; 99 p. October 2004.

Sponsor:

National Institute of Standards and Technology, Gaithersburg, MD

Keywords:

economic incentives; extreme events; interdependency; interdependent security; laboratory experiments; risk analysis; risk management; risk assessment

Abstract:

This report discusses the need for linking risk assessment, risk perception, and risk management in order to develop meaningful strategies for dealing with extreme events, i.e., low probability-high consequence events. We give special attention to economic incentives and to extreme events exhibiting interdependencies, either among individual stakeholders or among stakeholder groups. We also give special attention to the need for cooperation between the public and private sectors with the ultimate goal of generating sound strategies for reducing the risks of extreme events and reducing the damage should such catastrophes occur. We present a conceptual framework of how risk assessment, risk perception and risk management are linked with each other. Risk assessment evaluates the likelihood and consequences of prospective risks. Risk perception is concerned with the psychological and emotional aspects of risks. Risk management involves developing strategies for reducing the likelihood and/or consequences of extreme events. The discussion of risk assessment describes how the exceedance probability or EP curve is a convenient way of summarizing the nature of the risk and provides valuable input for different stakeholders to develop strategies for managing risk. The discussion of risk perception discusses how individual decisions on whether or not to adopt protective measures are influenced by psychological and emotional factors. Problems of coordination when facing interdependent security risks are also analyzed. In particular, we discuss the need for risk management strategies that involve both the private and public sectors for dealing with the negative externalities created by these interdependencies. The discussion of risk management strategies focuses on insurance and mitigation as two complementary strategies for reducing future losses and providing funds for recovery, and addresses the role of public-private partnerships in this regard. The use of controlled laboratory experiments to better understand household adaptive response to natural hazards is illustrated through an earthquake simulation that was tested with University of Pennsylvania undergraduate and graduate students.