“Misfortunes Never Come Singly: Managing the Risk of Chain Disasters”

Alexandra Brausmann, öffnet eine externe URL in einem neuen Fenster (University of Vienna)

with Lucas Bretschger and Aleksey Minabutdinov

Large economic, ecological, natural and health-related disasters have the poten-

tial to set off a sequence of secondary calamities, initiating cascading effects that

impose substantial additional economic costs. This paper examines the repercus-

sions of contagion effects for optimal public policy. We compare the optimality of

precautionary measures taken ahead of time with a ”reactive” approach to disaster

management, i.e. disaster-mitigation efforts adopted after the gravity of the first

shock has been established. We develop a novel dynamic stochastic framework,

where disaster arrivals are modelled via the Hawkes process which possesses a self-

excitation mechanism. We derive analytical solutions and show that the optimal

policy consists of devoting a stochastic fraction of output to disaster-mitigation.

The mitigation propensity is an increasing function of the Hawkes intensity and

essentially tracks disaster arrivals. The latter implies that the policy is indeed re-

active. This result is in contrast with the existing literature, which does not take

into account the possibility of contagion and therefore finds a constant mitigation

propensity to be optimal.