The Impact of Prudence on Optimal Prevention Revisited

Abstract

This paper re-examines the link between absolute prudence and self-protection activities. We show that the level of effort chosen by a prudent agent is larger than the optimal effort chosen by a risk-neutral agent if and only if the degree of absolute prudence is less than a threshold that is utility-independent. We explain this threshold by a trade-off between the variation of the variance and the level of the third moment of the loss distribution. We also discuss our result in terms of skewness. Our contribution extends the model of Eeckhoudt and Gollier (2005).Absolute prudence, Moments of the loss distribution, Self-protection, Variance, Skewness