Compensation of Uncertain Lost Earnings

The present value of expected lost earnings is in the Law and Economics literature normally regarded as the amount that makes a victim fully compensated at income losses. However, the present value measure disregards risk-aversion. In the framework of the von-Neumann-Morgenstern utility theory the risk-averse victim will be made whole by a compensation smaller than the present value of the stream of uncertain lost earnings. A rule for determining an immediate certainty equivalent for lost potential earnings when the victim is risk-averse is suggested. The equivalent depends not only on the degree of risk-aversion, but also on the correlation between future losses. The legal practice varies, but in many jurisdictions judges tend to pay less than the present value for uncertain lost earnings, which is in accordance with our results.