How much are YOU willing to risk?
Consider the following gamble: You are offered either a sum of money for certain or a lottery ticket that will give you a 50% chance of winning £10.000 and a 50% chance of winning nothing. What would be the certain sum that makes you indifferent whether to receive it or the lottery ticket?
Below you find two graphs that show my results with different sums and different probabilities.
These graphs show that I am a rather risk aversive person. Your graphs might look the same or you are a rather risk seeking individual, which would alter your curve from the bottom at lower sums and probabilities to the top with higher sums and probabilities.
I'm not sure I'd agree with your interpretation of the two graphs. Neither of them show the pronounced pattern of diminishing marginal utility that we see in the "textbook" graphs. In fact, both graphs show a slightly different pattern in the low £1000s than in the higher £1000s.
ReplyDeleteThe Certainty Equivalence graph actually suggests you are slightly risk-seeking in the lower £1000s, because there is a steeper curve from £25000 to £35000 than there is from £0 to £25000.
The Probability Equivalence graph actually shows almost a straight line, apart from a slight bump in the leftmost region. That indicates a degree of risk-neutrality, implying that you'd mostly be indifferent between a sure-think and a gamble with equivalent expected value.
Do you think of yourself as risk-neutral, risk averse, or a risk-seeking person? Which graph best describes you?