The Skin In The Game Heuristic for Protection Against Tail Events

TL;DR

This paper introduces the 'Skin In The Game' heuristic, a moral and systemic rule requiring risk-takers to bear some harm, aiming to mitigate tail risks and moral hazard in high-impact, uncertain domains.

Contribution

It proposes a global, morally mandatory heuristic that enforces exposure to harm for risk generators, addressing moral hazard and tail risk issues overlooked by standard economic theory.

Findings

The heuristic creates an absorbing state for agents, reducing harmful risk-taking.

It links ethical philosophy with risk management to promote accountability.

The rule aims to counter risk hiding and transfer in fat-tailed domains.

Abstract

Standard economic theory makes an allowance for the agency problem, but not the compounding of moral hazard in the presence of informational opacity, particularly in what concerns high-impact events in fat tailed domains (under slow convergence for the law of large numbers). Nor did it look at exposure as a filter that removes nefarious risk takers from the system so they stop harming others. \textcolor{red}{ (In the language of probability, skin in the game creates an absorbing state for the agent, not just the principal)}. But the ancients did; so did many aspects of moral philosophy. We propose a global and morally mandatory heuristic that anyone involved in an action which can possibly generate harm for others, even probabilistically, should be required to be exposed to some damage, regardless of context. While perhaps not sufficient, the heuristic is certainly necessary hence mandatory. It is supposed to counter voluntary and involuntary risk hiding$-$ and risk transfer $-$ in the tails. We link the rule to various philosophical approaches to ethics and moral luck.