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Concept
Risk-seeking
Summary
In accounting, finance, and economics, a risk-seeker or risk-lover is a person who has a preference for risk.
While most investors are considered risk averse, one could view casino-goers as risk-seeking. A common example to explain risk-seeking behaviour is; If offered two choices; either 100 or nothing, a risk-seeking person would prefer the gamble. Even though the gamble and the "sure thing" have the same expected value, the preference for risk makes the gamble's expected utility for the individual much higher.
Choice under uncertainty is when a person facing a choice is not certain of the possible outcomes or their probability of occurring. The standard way to model how people choose under uncertain condition, is by using expected utility. In order to calculate expected utility, a utility function 'u' is developed in order to translate money into Utility. Therefore, if a person has '' money, their utility would be . This is explored further when investigating potential "prospects". A prospect, in this context, is a list of expected payoffs and their probabilities of occurring. A prospect is summarised using the form;
The overall expected value of the prospect (A) is subsequently expressed as;
The expected utility, U(A), of the prospect is then determined using the below formula;
The utility function is convex for a risk-lover and concave for a risk-averse person (and subsequently linear for a risk-neutral person). Subsequently, it can be understood that the utility function curves in this way depending on the individual's personal preference towards risk.
Below is an example of a convex utility function, with wealth, '' along the x-axis and utility, '' along the y-axis. The below graph shows how greater payoffs result in larger utility values at an increasing rate. Showing that the person with this utility function is "risk-loving".
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