Mutual optimism and risk preferences in litigation

• Published in: International review of law and economics Vol. 75; p. 106157
• Main Author: Hylton, Keith N.
• Format: Journal Article
• Language: English
• Published: Elsevier Inc 01.09.2023
• Subjects: Arrow-Pratt risk measure; Economics of litigation; Mutual optimism; Prospect theory; Risk aversion; Risk-neutralizing probability measure; Settlement; D74; Risk aversion; Settlement; Prospect theory; Risk-neutralizing probability measure; Economics of litigation; Arrow-Pratt risk measure; D91; Mutual optimism
• ISSN: 0144-8188; 1873-6394
• DOI: 10.1016/j.irle.2023.106157

Why do some legal disputes fail to settle? From a bird’s eye view, the literature offers two categories of reasons. One consists of arguments based on informational disparities. The other consists of psychological arguments. This paper explores the psychological theory. It presents a model of litigation driven by risk preferences and examines the model’s implications for trials and settlements. The model suggests a foundation in Prospect Theory for the Mutual Optimism model of litigation. The model’s implications for plaintiff win rates, settlement patterns, and informational asymmetry with respect to the degree of risk aversion are examined. •Presents a formalization of the Mutual Optimism model of litigation.•Grounds the formalization in Prospect Theory.•Demonstrates that many patterns actually observed in litigation can be explained by the model.•Shows how the Mutual Optimism model can be combined with asymmetric information models.