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Definition of Risk Aversion
Risk aversion, also referred to as risk avoiding, is the likeliness of an investor to take the investment with a lower risk rather than the investment with a higher risk, given that the expected return for the two investments is the same. A risk-averse person is often not willing to take risk. This person would rather stick to low but guaranteed return investments rather than go for high return investments which are not guaranteed (Baker, 2011).
Why Rational Investors are Risk Averse
Normally, most investors are risk-averse. This is because; people prefer certainty to uncertainty when it comes to money matters. Rational investors prefer to remain risk-averse so as to minimize their exposure to the worst possible outcome.
Risk-averse employees would rather work in an organization where they have job security than engage in self-employment venture which has a higher rate of income. This is because, even though self-employment has the potential of bringing in a lot of money, it has the risk of losing the entire venture in time.
If a risk-averse investor is faced with the option of either investing in equities or a bank account, the investor will prefer to invest in a bank account. Even though, the equities have the possibility of a greater rate of return, most rational investors would go for the lower but guaranteed rate of return (Kolakowski, 2012).
Am I or My Firm Risk Averse? Why?
Most risk-averse investors make their investment decision by putting a lot of weight on the worst possible scenarios. However, the worst possible scenario has a low probability of ever occurring. Depending on the location where I grew up and the economic climate prevailing, I tend not to be risk-averse.
It is necessary for one to know that not being risk-averse is like gambling. In gambling, one can never be sure of winning. One has to consider how much one has to lose in the worst scenario and how many times the ‘gambling game’ will be repeated. If there is an opportunity of repeating the ‘gambling game’ a number of times, then the worst and best scenarios tend to balance.
The need for one to be risk-averse comes in when the ‘gambling game’ is only repeated a couple of times, or its not repeated at all. One should also be risk-averse if the venture is too high such that one may not afford to lose. Therefore, depending on the venture, I would choose whether to be or not to be risk-averse (Risk Averse, 2012).
Does Risk Averse Vary by Geographical Location?
Experience of an individual play a huge role in the person’s level of risk aversion. Individuals who grew up in very harsh economic environments tend to be more risk-averse than individuals from well developed economic climates. It is evident that people from countries which have been undergoing challenging economic times tend to be more risk-averse (Risk Aversion, 2012).
People who were young in the 1930s during the Great Depression tend to manage money in a very conservative way. This group of people shies away from the notion of increasing their investment if the return is not guaranteed. This is because these people have memories of the Great Depression; they fear that it might happen again. Therefore, both the time as well as the physical location of an individual plays a significant role in an individual’s risk averseness.
Baker, S. (2011). Risk Aversion. Web.
Kolakowski, M. (2012). Risk Aversion: Financial Careers Guide. Web.
Risk Averse. (2012). Web.
Risk Aversion. (2012). Web.