Risk Takers

Abstract

First paragraph: To take risks is to take decisions for which the favourability of outcomes is uncertain. Therefore, every individual and business entity is a risk taker at some level. However, the existence of risk takers who are prepared to put their capital and, or, reputation at risk in the hope of a financial reward is a necessary precondition for a capitalist model of society. In the discipline of financial economics, risk takers are subcategorised into risk lover, risk neutral and risk averse (Blake 2000). Traditional finance theory, applying assumptions of rational behaviour, argues that the majority of people are risk averters, i.e. risk averse. Given a choice of two investment opportunities with identical expected returns and uncertain but symmetrical probability distributions with different degrees of dispersion, i.e. risk, the less risky option is always selected by risk averters. Risk averters are said to have a declining marginal utility of wealth, see entries for utility theory. A risk neutral investor would be indifferent between the two options presented above. This is because, the potential for a less favourable outcome than that expected is exactly offset by the equal probability of a more favourable outcome. A risk lover would prefer the riskier choice because the utility conferred by a financial gain more than offsets the utility destroyed by a financial loss of equal magnitude. Under the above distribution assumption risk lovers, unlike risk averters, always have an increasing marginal utility of wealth (Tobin 1958).