scholarly journals Moving beyond the cost–loss ratio: economic assessment of streamflow forecasts for a risk-averse decision maker

2017 ◽  
Vol 21 (6) ◽  
pp. 2967-2986 ◽  
Author(s):  
Simon Matte ◽  
Marie-Amélie Boucher ◽  
Vincent Boucher ◽  
Thomas-Charles Fortier Filion
Keyword(s):  
Risk Aversion ◽  
Utility Function ◽  
Decision Maker ◽  
Economic Value ◽  
Economic Assessment ◽  
Risk Averse ◽  
Loss Ratio ◽  
Ensemble Forecasts ◽  
Streamflow Forecasts ◽  
Cara Utility

Abstract. A large effort has been made over the past 10 years to promote the operational use of probabilistic or ensemble streamflow forecasts. Numerous studies have shown that ensemble forecasts are of higher quality than deterministic ones. Many studies also conclude that decisions based on ensemble rather than deterministic forecasts lead to better decisions in the context of flood mitigation. Hence, it is believed that ensemble forecasts possess a greater economic and social value for both decision makers and the general population. However, the vast majority of, if not all, existing hydro-economic studies rely on a cost–loss ratio framework that assumes a risk-neutral decision maker. To overcome this important flaw, this study borrows from economics and evaluates the economic value of early warning flood systems using the well-known Constant Absolute Risk Aversion (CARA) utility function, which explicitly accounts for the level of risk aversion of the decision maker. This new framework allows for the full exploitation of the information related to a forecasts' uncertainty, making it especially suited for the economic assessment of ensemble or probabilistic forecasts. Rather than comparing deterministic and ensemble forecasts, this study focuses on comparing different types of ensemble forecasts. There are multiple ways of assessing and representing forecast uncertainty. Consequently, there exist many different means of building an ensemble forecasting system for future streamflow. One such possibility is to dress deterministic forecasts using the statistics of past error forecasts. Such dressing methods are popular among operational agencies because of their simplicity and intuitiveness. Another approach is the use of ensemble meteorological forecasts for precipitation and temperature, which are then provided as inputs to one or many hydrological model(s). In this study, three concurrent ensemble streamflow forecasting systems are compared: simple statistically dressed deterministic forecasts, forecasts based on meteorological ensembles, and a variant of the latter that also includes an estimation of state variable uncertainty. This comparison takes place for the Montmorency River, a small flood-prone watershed in southern central Quebec, Canada. The assessment of forecasts is performed for lead times of 1 to 5 days, both in terms of forecasts' quality (relative to the corresponding record of observations) and in terms of economic value, using the new proposed framework based on the CARA utility function. It is found that the economic value of a forecast for a risk-averse decision maker is closely linked to the forecast reliability in predicting the upper tail of the streamflow distribution. Hence, post-processing forecasts to avoid over-forecasting could help improve both the quality and the value of forecasts.

scholarly journals Moving beyond the cost-loss ratio: Economic assessment of streamflow forecasts for a risk-averse decision maker

2016 ◽  
Author(s):  
Simon Matte ◽  
Marie-Amélie Boucher ◽  
Vincent Boucher ◽  
Thomas-Charles Fortier Filion
Keyword(s):  
Utility Function ◽  
Decision Maker ◽  
Economic Value ◽  
Economic Assessment ◽  
Risk Averse ◽  
Loss Ratio ◽  
Ensemble Forecasts ◽  
South Central ◽  
Streamflow Forecasts ◽  
Cara Utility

Abstract. A large effort has been made over the past 10 years to promote the operational use of probabilistic or ensemble streamflow forecasts. Numerous studies have shown that ensemble forecasts are of higher quality than deterministic ones. Many studies also conclude that decisions based on ensemble rather than deterministic forecasts lead to better decisions in the context of flood mitigation. Hence, it is believed that ensemble forecasts possess a greater economic and social value for both decision makers and the general population. However, the vast majority, if not all, of existing hydro-economic studies rely on a cost-loss ratio framework that assumes a risk-neutral decision maker. To overcome this important flaw, this study borrows from economics and evaluates the economic value of early warning flood systems using the well-known CARA utility function, which explicitly accounts for the level of risk aversion of the decision maker. This new framework allows for the full exploitation of the information related to a forecasts' uncertainty, making it especially suited for the economic assessment of ensemble or probabilistic forecasts. Rather than comparing deterministic and ensemble forecasts, this study focuses rather on comparing different types of ensemble forecasts. There are multiple ways of assessing and representing forecast uncertainty. Consequently, there exists many different means of building an ensemble forecasting system for future streamflow. One such possibility is to dress deterministic forecasts using the statistics of past error forecasts. Such dressing methods are popular among operational agencies because of their simplicity and intuitiveness. Another approach is the use of ensemble meteorological forecasts for precipitation and temperature, which are then provided as inputs to one or many hydrological model(s). In this study, three concurrent ensemble streamflow forecasting systems are compared: simple statistically dressed deterministic forecasts, forecasts based on meteorological ensembles and a variant of the latter that also includes an estimation of variable uncertainty. This comparison takes place for the Montmorency River, a small flood-prone watershed in south central Quebec, Canada. The assessment of forecasts is performed for lead times of one to five days, both in terms of forecasts' quality (relative to the corresponding record of observations) and in terms of economic value, using the new proposed framework based on the CARA utility function. It is found that the economic value of a forecast for a risk-averse decision maker is closely linked to the forecast reliability in predicting the upper tail of the streamflow distribution.

scholarly journals Modeling of Risk Aversion Linked to Renewable Energy Policy and Decision-Maker Behavior

2022 ◽  
Author(s):  
Dieudonné Dieudo Ecike Ewanga
Keyword(s):  
Risk Aversion ◽  
Decision Maker ◽  
Decision Support Tool ◽  
Renewable Energies ◽  
Decision Makers ◽  
Risk Averse ◽  
Renewable Energy Policy ◽  
Support Tool ◽  
Electricity Grid ◽  
Concave Utility Function

This paper presents the behavior of decision makers, the possible choices and the strategies 1 resulting from the uncertainties related to the integration of renewable energies. Its uncertainties 2 are the risks associated with the volatility of renewable sources, the dynamics of energy production 3 as well as the planning and operation of the electricity grid. The goal is to model the risk-averse 4 decision-maker’s behavior and the choice of integrating renewable energies into the electrical system. 5 Following a bibliographic approach, we expose a methodology to model the decision-maker’s 6 behavior(risk aversion and predilection for risk) to risk taking. The risk-averse decision maker may 7 adopt nonlinear utility functions. Risk aversion is a behavior that reflects the desire to avoid risk 8 decisions and thus reduces the risk of adverse consequences. A decision support tool is provided to 9 the decision-maker to choose a best-fit strategy based on his preferences. The rational and risk-averse 10 decision-maker would seek to maximize a concave utility function instead of seeking to minimize its 11 cost. Taste or aversion to risk can be modeled by a thematic function of utility.

scholarly journals Risk aversion for losses and the Nash bargaining solution

2021 ◽  
Author(s):  
Hans Peters
Keyword(s):  
Risk Aversion ◽  
Decision Maker ◽  
Nash Bargaining Solution ◽  
Axiomatic Characterization ◽  
Nash Bargaining ◽  
Bargaining Solution ◽  
Risk Averse ◽  
Disagreement Point ◽  
Theoretic Characterization

AbstractWe call a decision maker risk averse for losses if that decision maker is risk averse with respect to lotteries having alternatives below a given reference alternative in their support. A two-person bargaining solution is called invariant under risk aversion for losses if the assigned outcome does not change after correcting for risk aversion for losses with this outcome as pair of reference levels, provided that the disagreement point only changes proportionally. We present an axiomatic characterization of the Nash bargaining solution based on this condition, and we also provide a decision-theoretic characterization of the concept of risk aversion for losses.

When Many Wrongs Make a Right

1988 ◽  
Vol 2 (1) ◽  
pp. 115-127 ◽  
Author(s):  
Steven A. Lippman ◽  
John W. Mamer
Keyword(s):  
Risk Aversion ◽  
Utility Function ◽  
Risk Reduction ◽  
Surprising Result ◽  
Risk Averse ◽  
Lower Tail ◽  
Risk Pooling ◽  
Exponential Bound ◽  
Poor Risk ◽  
Moment Bounds

When confronted by a sequence of independent, identical, favorable-though- risky investments, a risk-averse agent will in fact elect to invest as part of a large syndicate even if he or she would not undertake even one of the investments by himself or herself. This willingness to invest emanates from the risk reduction associated with the risk pooling effected by the syndicate. Our first two theorems describe the syndicate size needed to induce the agent's participation.The consequence of adding risks is considered next. We demonstrate that the agent will undertake a large number of these independent investments by himself or herself even if each investment taken by itself constitutes a poor risk. The conditions needed to ensure this somewhat surprising result are (a) moment bounds on the investments, and (b) either a polynomial or an exponential bound on the lower tail of the agent's utility function. Finally, we draw the connection between this result, proper risk aversion, and monotonicity of the agent's absolute aversion to risk.

scholarly journals The Stochastic Cash Balance Problem with Fixed Costs: The Risk-averse Case

2014 ◽  
Vol 2 (6) ◽  
pp. 520-531
Author(s):  
Shuren Liu ◽  
Pei Tang
Keyword(s):  
Utility Function ◽  
Decision Maker ◽  
Optimal Policy ◽  
Ambiguity Aversion ◽  
Exponential Utility ◽  
Risk Averse ◽  
Fixed Costs ◽  
Cash Balance ◽  
Balance Problem ◽  
Exponential Utility Function

AbstractThis paper discusses multi-period stochastic cash balance problem with fixed costs when the decision maker is risk averse. By using the consumption model introduced by Chen et al, we characterize the structure of the optimal policy for the stochastic cash balance problem under the general increasing concave utility function and exponential utility function, respectively. We show that the structure of the optimal policy for a decision maker with exponential utility function is almost identical to the structure of the optimal risk-neutral operations policy. Furthermore, we extend the results for the exponential utility function to the ambiguity aversion case.

The semi-martingale equilibrium equity premium for risk-neutral investors

2018 ◽  
Vol 05 (04) ◽  
pp. 1850035
Author(s):  
George M. Mukupa ◽  
Elias R. Offen
Keyword(s):  
Risk Aversion ◽  
Utility Function ◽  
Equity Premium ◽  
Discrete Distribution ◽  
Optimal Consumption ◽  
Risk Averse ◽  
Power Utility ◽  
Risk Neutral ◽  
Linear Utility ◽  
Linear Utility Function

In this paper, we study the risk-neutral investor’s equilibrium equity premium in a semi-martingale market with arbitrary, normal, binomial and gamma jumps. We simulate graphs for discrete distribution of jump amplitudes in order to study the parameter effect. The equity premium for this investor remains the same regardless of [Formula: see text] and [Formula: see text] variations in the linear utility function. In fact, there is no optimal consumption for [Formula: see text]. For normal jumps, our results are consistent with the risk-averse investor’s power utility effect on the equity premium. However, the binomial and gamma amplitudes show significant variations between risk neutrality and risk aversion.

Eliciting Risk Preferences and Elasticity of Substitution

2020 ◽  
Vol 17 (4) ◽  
pp. 314-329
Author(s):  
Johan Burgaard ◽  
Mogens Steffensen
Keyword(s):  
Risk Aversion ◽  
Discount Rate ◽  
Predictive Power ◽  
Recursive Utility ◽  
Risk Averse ◽  
Indirect Utility ◽  
Consistent Estimation ◽  
On Certainty ◽  
Certainty Equivalents ◽  
Elasticity Of Intertemporal Substitution

Risk aversion and elasticity of intertemporal substitution (EIS) are separated via the celebrated recursive utility building on certainty equivalents of indirect utility. Based on an alternative separation method, we formulate a questionnaire for simultaneous and consistent estimation of risk aversion, subjective discount rate, and EIS. From a representative group of 1,153 respondents, we estimate parameters for these preferences and their variability within the population. Risk aversion and the subjective discount rate are found to be in the orders of 2 and 0, respectively, not diverging far away from results from other studies. Our estimate of EIS in the order of 10 is larger than often reported. Background variables like age and income have little predictive power for the three estimates. Only gender has a significant influence on risk aversion in the usually perceived direction that females are more risk-averse than males. Using individual estimates of preference parameters, we find covariance between preferences toward risk and EIS. We present the background reasoning on objectives, the questionnaire, a statistical analysis of the results, and economic interpretations of these, including relations to the literature.

scholarly journals Market-based instruments for risk-averse farmers: rubber agroforest conservation in Jambi Province, Indonesia

2016 ◽  
Vol 22 (2) ◽  
pp. 133-155 ◽  
Author(s):  
Utkur Djanibekov ◽  
Grace B. Villamor
Keyword(s):  
Income Inequality ◽  
Risk Aversion ◽  
Real Options ◽  
Risk Averse ◽  
Variance Model ◽  
Income Uncertainty ◽  
Real Options Approach ◽  
Pigovian Taxes ◽  
Rubber Agroforest ◽  
Mean Variance

AbstractThis paper investigates the effectiveness of different market-based instruments (MBIs), such as eco-certification premiums, carbon payments, Pigovian taxes and their combination, to address the conversion of agroforests to monoculture systems and subsequent effects on incomes of risk-averse farmers under income uncertainty in Indonesia. For these, the authors develop a farm-level dynamic mean-variance model combined with a real options approach. Findings show that the conservation of agroforest is responsive to the risk-aversion level of farmers: the greater the level of risk aversion, the greater is the conserved area of agroforest. However, for all risk-averse farmers, additional incentives in the form of MBIs are still needed to prevent conversion of agroforest over the years, and only the combination of MBIs can achieve this target. Implementing fixed MBIs also contributes to stabilizing farmers’ incomes and reducing income risks. Consequently, the combined MBIs increase incomes and reduce income inequality between hardly and extremely risk-averse farmers.

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