StudentShare
Search

# Risk aversion - Assignment Example

Summary
1. Risk aversion depends upon an individual’s relative preference for a certain income over a fair gamble entailing an expected income of the same value as the certain income. An individual is identified as being “risk averse” the certain income is preferred over a fair gamble with an expected income equal to the certain income…

## Extract of sample "Risk aversion"

Download file to see previous pages Generally, the extent of risk aversion is the degree to which the individual prefers the certain income over the uncertain income. In terms of a utility function, this translates to the distance between the utility generated by the certain income and the utility generated by the gamble which has an expected income equal to the certain income. Obviously, for a concave utility function, the utility of the certain income will lie above the utility of the uncertain income with the same expected value. For a convex utility function this will be reversed. These are explained in the diagram below (figure 1). Figure 1: Risk Aversion and the curvature of the utility function In the diagram above, a rational individual is considered whose preferences are represented by the utility function U(.) defined over money incomes X. Suppose the individual has a choice of either playing a lottery with two possible outcomes: X1 and X2, where X2 > X1. To keep things simple let us further assume that both outcomes equally likely to occur. That is, both outcomes X1 and X2 have a probability of occurrence = ?. Thus if X1 is realized the individual gets U(X1) and if X2 realizes, the individual derives U(X2). Then, the expected income from the lottery is ?[X1+X2] and the expected utility is ? [U(X1) +U(X2)]. Now, observe that whether the utility derived by the individual from a certain income of ?[X1+X2] which is equal to U?[X1+X2] lies above ? [U(X1) +U(X2)], the expected utility from the lottery with an expected earning of ?[X1+X2], depends upon the curvature of the function. When the utility function is concave, . This shows that the individual prefers a certain income over and above a lottery with an expected income that is equal to certain income. Extending this logic it is simple to show that a risk loving individual will have a convex utility function while a risk neutral person will have a utility function that has a constant slope. Also, greater the distance between U?[X1+X2] and ? [U(X1) +U(X2)], the more risk averse is the individual, since the preference for the certain income is even greater in that case. This implies that the more concave the utility function the greater will be the risk aversion of the individual. Similarly, greater the convexity of the utility function, greater will be the individual’s love for risk. Therefore, it can be generally agreed upon that a risk-averse person will have a concave utility function while a risk lover will have a convex utility function. A risk neutral person’s preferences will be designated by a utility function with a constant slope. Now, Mr. D’s Utility function is: Then, and, Since , and thus, Mr. D’s utility function is positively sloped. A positively sloped utility function implies more income is preferred to less by Mr. D. For his attitude towards risk, the curvature (sign of the second order derivative) of the utility function has to be considered. Now, and, Therefore, the utility function is convex if the value of the positive parameter and it is concave if the positive parameter . If the utility function is concave, Mr. D is risk averse while if the utility function is convex, then Mr. D is in nature a risk loving person. Therefore, regarding the attitude of Mr. D towards risk, we conclude the following: Mr. D’s attitude towards risk depends on the value of the parameter . If , Mr. D loves ...Download file to see next pagesRead More
Cite this document
• APA
• MLA
• CHICAGO
(“Risk aversion Assignment Example | Topics and Well Written Essays - 2000 words”, n.d.)
(Risk Aversion Assignment Example | Topics and Well Written Essays - 2000 Words)
https://studentshare.org/macro-microeconomics/1398038-no-title.
“Risk Aversion Assignment Example | Topics and Well Written Essays - 2000 Words”, n.d. https://studentshare.org/macro-microeconomics/1398038-no-title.
Click to create a comment or rate a document

## CHECK THESE SAMPLES OF Risk aversion

### High-Risk Family Risk Assessment

...On any given day 800,000 people are homeless in the United s and homelessness is one such high risk family group amongst others (Moses, n.d Families with children are the fastest growing segment in the homeless population. Nearly one-quarter of the homeless population comprises of children. The reasons for homelessness could be with structural or individual. Structural reasons include social assurance in the form of social security or insurance or mental health support (Burt et al., n.d.). Due to the rising economy, increased rent has made accommodation out of reach of the poorest Americans. Currently thirty-one million people live in poverty in America and when unable to pay the rent, streets and homeless shelters are the only alternative...
6 Pages(1500 words)Term Paper

### Risk Management of Space Tourism

The necessitates that adventure tourism is encouraged but after incorporating certain lessons learned in the process. Adventure tourism has led to advancements in technology. The economy of the region experiences growth and the cultural identity of the region remains intact. Risk and safety management has to be enforced through Codes of Conduct which could differ across sectors. Space tourism will result in positively impacting the economy and society while the environmental impact is minimal. Risk management, in this case, has been taken care of and this could bring about an absolutely new dimension in the field of adventure tourism.

The human mind is creative and forever looks for change, challenge, and adventure. Hum...
12 Pages(3000 words)Case Study

### Project Risk Assessment: Qualitative Versus Quantitative Approach

The risks may vary in terms of nature or scope according to the situation. So since the risk is so common in project management, a very important aspect of managing a project is analyzing all the possible risks that are associated with that particular project. It makes no sense of going on with a project and not giving a thought to the risks that could affect the success. Once these risks are analyzed, the project manager will have all the possible risks in front of him. He will know the degree of risk and also the benefits that the organization will get if the risk is taken. Therefore only after a risk analysis, the project manager is in a position to conclude whether or not it is worth taking the risk and going on with a certain...
6 Pages(1500 words)Assignment

### Heavy Menstrual Bleeding, Its Treatment and Risk

... of Faculty of …….. Heavy Menstrual Bleeding, its treatment and risk Case Study of the patient of patient: Diagnosis of patient: Multiple fibroids in the intramural and sub serous walls. Differential Diagnosis: Dysfunctional Uterine Bleeding, Chronic PID, Hypothyroidism Complications: Anaemia, Uterine Obstructions ( hydronephrosis) Name of Student: Group No: Date: Heavy Menstrual Bleeding The case history of the patient indicates many details that are very useful in diagnosing and providing the adequate medical assistance...
6 Pages(1500 words)Case Study

### The Issue of Business Risk

...Introduction The large scale corporate scandals such as Enron and WorldCom and the current economic crisis has resulted into the debate regarding theeffectiveness of the audit as the valid tool to critically analyze and expose the illegal and imprudent management and accounting practices that have resulted into the losses for the shareholders. The development of approaches such as Business Risk Audit was one of the manners in which audit community as a whole attempted to bring in a new and more refined approach to audit in order to overcome the traditional weaknesses of the audit tools and also cope with the increasing complexities of the modern business. This new approach was based on assessing the risk in business as well as process...
6 Pages(1500 words)Literature review

### Risk Management

Financial risk is the risk of getting losses because of market changes or the operations of competitors in the market (Das, 2006 ) On the other hand, operational risk refers to those risks of losses due to non-financial business inputs, outputs, and operations. Operational risk can be further classified into pure and speculative risks. Pure risks are those that on occurrence lead to loss and if they do not occur, they would not lead to any profits either. Speculative risks are those kinds of risks whereby on occurrence they lead to a loss but when they do not occur, they lead to profits (Das, 2006). These two kinds of risks occur on a daily basis in any market situation and each business unit needs preparation for them.
Many...
7 Pages(1750 words)Term Paper

### Indoor Air Pollution as a Risk Factor for Lung Cancer

...Executive Summary In the UK, most individuals spend over 80% of their time completing activities in indoor environments, such as schools, offices, private homes, shopping centres, hospitals, day care and so on. Therefore, an assessment of the health risks associated with contaminated air is essential to assist stakeholders in taking the appropriate measures to promote strategies for reducing the emissions of appliances, controlling indoor emissions and individual exposure to harmful emissions. This study examines the relationship between gas stoves and household heating appliances and their contribution to the emission of nitrogen dioxide, and thus the health risk they pose to the human respiratory system. However, the approaches used...
12 Pages(3000 words)Assignment

### Texting While Driving: A Life at Risk Behind the Wheels

...First and and Section Number of Assignment Texting While Driving: A Life at Risk Behind the Wheels Introduction Mobile devices have become not just an integral but an inevitable part of everyday lives. The vast number of purpose they serve, apart from being simply a means of communication, makes it almost impossible not to use them in a day, sometimes even in a minute. One would check his cellular phone every so often regardless of how important the task at hand is or how limited the time left to spend with valued people. At times, if it is not possible to do two things at the same time, then even for a fraction of a second, the mobile phone somehow comes first. This is where the problem begins. Setting aside the social and work-related...
7 Pages(1750 words)Essay

### Assessment and Management of Risk within Engineering

...Assignment 2: Assessment and Management of Risk within Engineering Insert (s) Assignment2: Assessment and Management of Risk within Engineering Task 2a: Audit Report As a health & safety advisor for the engineering company, there are a number of ways through which I would use safety audit to address the rising cases of minor non reportable accidents and other safety awareness concerns in the company. According to Kyle (2011), a safety audit is particularly important in providing a detailed assessment of the all the engineering activities being carried out in the company and measuring such activities against the standard legal requirement and recommended best practices. For example, in order to ensure the risks associated with the daily...
9 Pages(2250 words)Assignment

### An Investigation on the Significance of Risk Management on Business Performance of Tesco Company

...AN INVESTIGATION ON THE SIGNIFICANCE AND IMPACT OF RISK MANAGEMENT ON BUSINESS PERFORMANCE OF A COMPANY: A CASE STUDY OF TESCO, UK Table of Contents Table of Contents 2 1.0 Introduction: 4 1.1 Introduction: 4 1.2 Background of the proposed study: 4 1.3 Rationale of the proposed study: 5 1.4 Research aims and objectives: 5 1.5 Research questions: 6 1.6 Research hypothesis: 6 1.7 Structure of the proposed research work: 6 2.0 Literature review: 8 2.1 Introduction: 8 2.2 Risk management: 8 2.3 Significance of risk management: 9 2.4 Major types of risks: 10 2.5 Risk Management Process: 11 2.6 Current risk management strategy of Tesco: 12 2.7 Chapter summary: 13 3.0 Research methodologies: 13 3.1 Introduction: 13 3.2...
20 Pages(5000 words)Research Proposal