Litigation Funding: An Economic Analysis

Abstract

Basic economic analysis of litigation funding shows that risk neutral plaintiffs without budget constraints will not accept funding unless they are pessimistic relative to the funder. Risk aversion makes a plaintiff who shares probabilistic beliefs with the funder act observationally equivalent to a pessimistic, risk neutral plaintiff, so she will accept funding as well. An important benefit of litigation funding - evident from the application of a change of measure to risk neutral probabilities, an analytical approach widely used in the pricing of financial derivatives - is that it moves litigation outcomes closer to risk neutral outcomes and therefore closer to actions consistent with the plaintiff's perceived merits, something that is of underemphasized importance in law and procedure. The best funding outcomes (for investors) are likely when plaintiffs are risk averse or budget constrained. Poor outcomes are more likely when funded plaintiffs are risk neutral and unconstrained.