The Skin In The Game Heuristic for Protection Against Tail Events

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 slowness of 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. (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.