HCOL 195 10/21/09

This will be short. We filled out the “attitude towards risk” form and plotted our risk profile. We found three typical forms, namely:

Risk Averse Profile

Risk Averse Profile

The first, risk-averse profile is a very common profile; it says that a person, when considering a gain, is willing to accept less than the fair or expected value of a risky proposition in order to lock in a sure thing gain. So, for example, one might be willing to accept $4,000 as a sure thing rather than a 50-50 chance on a gain of $10,000. Similarly, one might be willing to accept a sure loss rather than run the risk of a much larger loss that only happens with some probability. Most people have a risk profile like this.

Risk Neutral Profile

Risk Neutral Profile

This profile is risk neutral (a straight line). It represents the risk profile of a large company, like an insurance company, that has many bets out, some of which it will win and some of which it will lose, but which can be predicted statistically with high accuracy by the companies actuaries. The difference between this kind of risk profile for an insurance company and the risk-averse profile of a typical insurance buyer (the first plot) explains how it is that people will willingly buy insurance, willing to pay a fixed premium to an insurance company, to (for example) avoid financial disaster if their house burns down, and at the same time the insurance company is willing to take on this risk, since they can charge each policy holder a premium that will, on average, more than cover the expected losses in aggregate. Because of this difference, the insurance company can expect a profit with a high degree of certainty, a profit that will be distributed to the shareholders as a dividend or (in the case of a mutual insurance company, which is owned by the people who have policies) a reduction of premiums.

Risk Seeking Profile

Risk Seeking Profile

This last profile is anomalous: It is risk averse for gains, but risk seeking for losses. It is sometimes seen in practice at casinos, where someone who is “down” may take extraordinary risks to try and get even. This is not usually a good idea.

Finally, we had a visit from Brit Chace, the HC Student Fellowship Advisor, on fellowship and scholarship opportunities (like the Rhodes and Marshall Scholarships, which allow students to study in England, and the Goldwater Scholarships). Her office is right across the hall from our classroom, and she encourages everyone to visit with her and discuss these opportunities.

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