Abstract

The relationship between willingness to pay to reduce the probability of an adverse event and the degree of risk aversion is ambiguous. The ambiguity arises because paying for protection worsens the outcome in the event the adverse event occurs, which influences the expected marginal utility of wealth. Using the concept of downside risk aversion or prudence, we characterize the marginal WTP to reduce the probability of the adverse event as the product of WTP in the case of risk neutrality and an adjustment factor. For the univariate case, the adjustment factor depends on risk aversion and prudence with respect to wealth. For the bivariate case, the adjustment factor depends on risk aversion and cross-prudence in wealth.