Thursday, October 6, 2005
Is it helpful to talk about "risk aversion" when we are talking about transactions among sophisticated parties? Victor Goldberg (Columbia) doesn't think so. He prefers thinking about the problem as "risk management," and develops the idea in an interesting new paper, Risk Management in Long-Term Contracts. Here's the abstract:
Long-term contracts are designed to manage risk. After a brief discussion of why it is unhelpful to invoke risk aversion for analyzing serious commercial transactions between sophisticated entities, this paper focuses on adaptation to changed circumstances. In particular, it considers the options to abandon and the discretion to change quantity. It then analyzes a poorly designed contract between Alcoa and Essex showing how the parties misframed their problem and designed a long-term contract that was doomed to fail.