WFU Law School
Law & Valuation
2.1.1 Returns

2.1.2 Risk

Risk is often understood as the possibility of loss. But risk, in financial terms, is really a way to talk about a range of possibilities -- the variability of returns. In short, risk is a way to describe degrees of uncertainty. For example, it is said that a one-year government note that will pay 4.5% interest has no risk, because the bondholder is certain of payment in one year. (Of course, the government might default, but financial economists generally don't even want to think of that.) But a company's common stock has risk because there is no assurance that it will earn dividends -- the company might not have earnings, or the board could postpone declaring dividends, or the company could go bankrupt. On the other hand, the company might pay handsome dividends -- that also is a possibility!

Next we pause to consider the fundamental nature of risk and its pervasive role in our decisionmaking process—both in general and legal contexts. This sets the stage for the remainder of this chpater when we look much more closely at the components of risk, their relation to each other, and how they can be applied to make decisions about future value.

In addition, risk should be understood as having multiple dimensions. Too often we think of risk in isolation. Instead it is often more realistic to see risk as it affects multiple, related outcomes. For example, rain is a risk to a farmer -- with mixed effects. Rain increases the chances his crops will grow, it makes the air smell fresh, and it causes his tractor to get stuck in the mud.

Example

Everyday economics. How the dismal science applies to your life.

Is Your Life Worth $10 Million? Nope. But your grandson's will be. By Steven E. Landsburg Posted Slate.com Monday, March 3, 2003, at 6:22 AM PT

While touring the magnificent old Dupont estate, I overheard an awestruck gardener mutter, "You can see why these people would have hated to die worse than anybody." I know what he meant. Life is dear, but life is dearer when you're rich.

You're richer than your grandparents, so your life is worth more than theirs. That's why you live in a safer world than they did: As life gets more valuable, we strive harder to protect it.

What does it mean to say that one life is "worth more" than another? Aren't all lives infinitely precious? Well, no, at least not in any sense that's at all useful for making hard policy decisions about things like job safety and access to medical care. (More>>)

 

"The Value of a Statistical Life: A Critical Review of Market Estimates throughout the World"

BY: W. KIP VISCUSI
Harvard Law School
National Bureau of Economic Research (NBER)

JOSEPH E. ALDY
Harvard University
Department of Economics

Document: Available from the SSRN Electronic Paper Collection:
http://papers.ssrn.com/paper.taf?abstract_id=379270

Paper ID: NBER Working Paper No. W9487
Date: February 2003

Paper Requests:
Full-Text downloads are available from SSRN Online for $5.

ABSTRACT:

A substantial literature over the past thirty years has
evaluated tradeoffs between money and fatality risks. These values in turn serve as estimates of the value of a statistical life. This article reviews more than 60 studies of mortality risk premiums from ten countries and approximately 40 studies that present estimates of injury risk premiums. This critical review examines a variety of econometric issues, the role of unionization in risk premiums, and the effects of age on the value of a statistical life. Our meta-analysis indicates an
income elasticity of the value of a statistical life from about 0.5 to 0.6. The paper also presents a detailed discussion of policy applications of these value of a statistical life estimates and related issues, including risk-risk analysis.


 

Student paper

Here is a student paper which discusses a famous example of a company that utilized a cost/benefit analysis to determine that it was "better" to allow dangerous vehicles to be sold than to correct a design flaw. Christopher Leggett, The Ford Pinto Case: The Valuation of Life as It Applies to the Negligence-Efficiency Argument.

2.1.1 Returns

©2003 Professor Alan R. Palmiter

This page was last updated on: August 5, 2003