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Portfolio Theory for Regional Disaster Analysis and Policy

Abstract My paper describes a portfolio theoretic framework for exploring the causes and consequences of major disruptions on regions and communities. The approach can be related to theories of financial portfolio management, optimal insurance, moral hazard, and ambiguous uncertainty, and the empirical literature on sustainable livelihoods, robust engineering, and disaster management. The present paper explains how Markowitz (1959) portfolio management theory may be adapted to the situation of a small region facing periodic and irregular disruptions in local and export markets, and used to select a portfolio of disaster mitigating strategies that maximize societal utility. This theory is implemented empirically using a computer simulation model. Model simulations show how the potential for major disruptions varies with economic policy, increasing rapidly with the risk-propensity of policy-makers or policies that increase the likelihood of concatenated events. Moreover, strategies that reduce ambiguity or protect critical elements in cascading disasters provide far more robust policy.