Regulating Ambiguous Risks: The Less than Rational Regulation of Pharmaceuticals

The US Food and Drug Administration (FDA) balances risks and benefits before approving pharmaceuticals. But powerful behavioral biases that lead to the mishandling of uncertainty also influence its approval process. The FDA places inordinate emphasis on errors of commission versus those of omission, a bias that is compounded by its desire to avoid blame should risks eventuate. Despite extensive testing, uncertainties inevitably remain.

We often learn about the risks of drugs after they are on the market. And there are off-label uses of drugs, which are not part of the initial testing. The FDA shows a strong aversion to ambiguous risks. This is the opposite of what is desirable.

For any given initial expected risk level, optimal risk-taking decisions involving uncertainty in a multiperiod world should prefer ambiguous risks and the potential for learning relative to well-established risks of the same magnitude. Therefore, the FDA should capitalize on option value.