Risk aversion

seedling

planted May 25, 2021

If we don't expect a significant advantage by taking a risk, we don't like taking risks. We tend to prefer a situation with a certain, but guaranteed payoff to a risky situation with a higher payoff.

Think about the following situation: You have the choice between these to options:

1. play a game that gives you a 50% chance to win 85€ or get nothing at all
2. getting 40€ straight away

Most people take the 40€.

However, the expected outcome of game 1 is 42,5€ (85*0,5), while the second option only has an outcome of 40. So even if the expected outcome is higher, the risky version doesn't yield a significant advantage. If this difference is not significantly higher, the safe version seems like a much better choice to most people.

But there are scenarios where the risky option can be more attractive, depending on your reference point: if you have the chance of either getting a save gain or loose and gain, you are likely to go with the save option. However, if you have the option to either lose a bit, or take a chance to lose more or gain something, you might probably take you chances to at least try to avoid loss.