Carrie has a “certainty equivalent” to a risky gamble’s expected value that is less than the gamble’s expected value. Carrie shows
A. risk aversion.
B. risk preference.
C. risk indifference.
D. a strange outlook on life.
Answer Explanation for Question: Carrie has a “certainty equivalent” to a risky gamble’s expected value that is less than the gamble’s expected value. Carrie shows
The concept of risk aversion refers to the tendency for people to prefer outcomes with low uncertainty to those with high uncertainty, even if the latter has the same or a higher monetary value than the former. Risk aversion describes the preference for a predictable outcome to a highly uncertain one. Investors who are risk-averse might opt to put their money into a bank account with a low but guaranteed interest rate rather than into a stock with potential high returns, but a risk of losing value.
In general, a risk averse agent prefers the expected value of a gamble over the gamble itself. Gambling consists of three elements; a set of outcomes, the probability associated with each outcome, and the payoff from each outcome.
Investors should be aware of the concept of risk aversion. Risk-averse investors prefer investments with a guaranteed, or “risk-free,” return. Even if the return is relatively low, they prefer this to higher potential returns with a greater degree of risk.
Investors who are extremely risk-averse prefer investments such as government bonds and certificates of deposit (CDs) over higher-risk investments such as stocks and commodities. In exchange for being able to earn higher returns on investment, investors with a higher risk tolerance – or lower levels of risk aversion – are willing to accept higher levels of risk.