Risk aversion in the value of information analysis: application to lake management - Stochastic Environmental Research and Risk Assessment

We analyze the relationship between the value of information (VOI) and the decision-maker’s risk aversion in the lake monitoring where one needs to decide about whether to implement costly management actions or not. We calculate the value of perfect as well as imperfect information for risk neutral and risk averse decision-makers. The risk aversion is measured using the certain equivalent and the Arrow-Pratt risk aversion measures, which are defined using the derivatives of the utility function. We consider two utility functions for a risk averse decision-maker, an exponential utility and a power utility function, and demonstrate their use with lake management data from Finland. The results show that, in this context, a risk averse decision-maker’s VOI may be lower or higher than a risk neutral decision-maker’s VOI, depending on the prior probability of the lake being in the need of management actions and the cost of the actions. The risk aversion seems to have a clear impact on decisions. This may encourage the decision-makers to contemplate their risk preferences instead of hastily assuming the risk neutrality.