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The Reaction of the Risk-Averse to the Speed of Legal Change

This is the graphic of that displays the preference that risk-averse individuals have for the the incremental change of common law. Unanticipated changes of the law are risks that individuals seek to avoid. Common law produces the change by virtue of small steps taken by courts who evolve the law as a side-product of resolving disputes. Civil law systems change the law by the legislature, which only engages the change if the social benefit outweighs the cost of its action. As a result, civil law changes less frequently but by larger increments. 

This graphic shows how risk averse individuals prefer dividing a given change over smaller increments. The expected gain due to the legal change is normalized to 1 (100%) and is on the vertical Z-axis which measures the preference of individuals by asking what certain fraction of that gain they would consider equivalent to the uncertain gain. This is the notion of "certainty equivalent." Obviously the riskier the gamble and the more risk-averse the individual, the smaller a fraction does certainty-equivalent becomes. (Risk-preferring individuals would place a premium on the gamble, but ignore them as they are not representative.) Thus, as risk-aversion increases, individuals consider the uncertain gain equivalent to a smaller certain amount. 

The point of the graphic is that whatever individuals risk-aversion may be, they will always prefer a given legal change occurring over more periods, more gradually, compared to the same change happening at once.

The "Periods" axis indicates the intervals over which legal change occurs. The range of the graph is from the change occurring over a single period (1) to occurring over 10 periods. Given an individual's level of risk aversion, dividing the legal change over more periods is always preferable (increases the certainty equivalent), particularly in the first periods and particularly when risk aversion is more pronounced. The risk aversion depicted in the graph is "constant relative risk aversion" and the coefficient of risk aversion ranges from .1 to 4.

See Georgakopoulos, Predictability and Legal Evolution.

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