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Risk Aversion
There are three risk attitudes (risk aversion, risk seeking, and risk neutrality). The risk attitude of “risk aversion” is distinguishable from the concept of “loss aversion.” This entry discusses risk attitudes and then examines the early concepts of risk aversion in the work of mathematician Daniel Bernoulli in 1738 and the psychological research of Amos Tversky and Daniel Kahneman extending the theories in the last quarter of the 20th century.
Risk Attitudes
Risk-Averse Attitude
A risk-averse attitude is the attitude of an individual that he or she will be unwilling to accept a risk in the following situation: When presented a choice as a trade-off between a gamble and a sure thing of equal expected value, the risk-averse individual will be more likely to take the sure thing and not take the gamble. For example, when presented a choice between a gamble and a sure thing with the same value, for example, the choice between a 50:50 trade-off (50% chance of living an additional 1,000 days of life at the end of one's life and a 50% chance of living no more additional days of life at the end of one's life = Expected value [EV] = 500 days of life) and a sure thing (EV = 500 days of life), the risk-averse individual will choose the sure thing over the gamble.
A stronger version of risk aversion can take the following form: When presented a choice between a gamble with a higher expected value (than a sure thing) and the sure thing, the risk-averse individual will have a preference for the sure thing and reject a gamble even when that gamble has a higher expected value compared with the sure thing.
For example, when presented the choice between a 60:40 trade-off (60% chance of living an additional 1,000 days of life at the end of one's life and a 40% chance of living no more additional days of life at the end of one's life = EV = +600 days of life) and a sure thing (EV = +500 days of life), the risk-averse individual will still choose the sure thing over the gamble.
Risk-Seeking Attitude
A risk-seeking attitude on the part of an individual is the attitude that he or she will be willing to accept a risk in the following situation: When presented a choice as a trade-off between a gamble and a sure thing of equal expected value, the risk-seeking individual will be more likely to take the gamble. For example, when presented a choice between a gamble and a sure thing with the same value, for example, the choice between a 50:50 trade-off (50% chance of living and losing 1,000 days of life from the end of one's life and a 50% chance of living and losing no additional days of life at the end of one's life = EV = −500 days of life) and a sure thing (EV = −500 days of life), the risk-seeking individual will choose the gamble over the sure thing.
A stronger version of risk seeking can take the following form: When presented a choice between a gamble with a lower expected value (than a sure thing) and the sure thing of a higher expected value, the risk-seeking individual will reject the sure thing and have a preference for the gamble even when the gamble has a lower expected value compared with the sure thing. For example, when presented the choice between a 60:40 trade-off (60% chance of losing 1,000 days of life at the end of one's life and a 40% chance of losing no days of life at the end of one's life = EV = −600 days of life) and a sure thing (EV = −500 days of life), the risk-seeking individual will still choose the gamble over the sure thing.
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