Cost-Effectiveness Analysis with Risk Aversion

Graff Zivin, J, “Cost-Effectiveness Analysis with Risk Aversion,” Health Economics 10(2001): 499-508.

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This paper discusses why, in a medical context, the standard assumption of a risk-neutral social planner is inappropriate and develops a framework for conducting cost-effectiveness (CE) analysis when social planners are risk-averse. This framework demonstrates that if new medical interventions are variance increasing (decreasing), the risk-neutral approach will approve (reject) projects that should be rejected (accepted). This methodology is applied to two medical interventions that have been previously evaluated and considered cost-effective in the published literature. Since both conclusions assumed risk neutrality we determine the level of societal risk-aversion that would be necessary to reject these new interventions and compare these levels to previous estimates of risk-aversion in the economics literature. We find that for reasonable values of the risk-aversion parameter, only one of the two interventions should be approved. It is our recommendation that the cut-off risk aversion parameter (the level of risk-aversion above which a project would be rejected) should become a standard reported figure in future CE studies.