Question

Suppose I were to offer you the following choice:

1. $10 for certain or,
2. I flip a fair coin, and give you $5 if it comes up heads and $15 if it comes up tails.

What would a risk-averse person choose? What would a risk-loving person choose? What would a risk-neutral person choose? What would you choose? Are you risk-averse, risk-loving or risk-neutral in this context? What about other contexts?

Would it make any difference if it were:

1. $10000 for certain or,
2. I flip a fair coin, and give you $5000 if it comes up heads and $15000 if it comes up tails.

Why or why not?

What about if it were:

1. $10000 for certain or,
2. I flip a fair coin, and give you $0 if it comes up heads and $20000 if it comes up tails?

Answer 1

1. If it were $10 for certain:

A rish averse person wil go for option (a), $10 for certain. A risk averse person is someone who likes to play it safe all the time, he may receive less return but he will always hesitate to go for a risker option and always prefers certainity.

A risk loving person will go for option (b), where if heads comes, he get's $5 and if tails comes, he gets $15. A risk loving person is someone who likes to go for increased risk if it is offering a higher return.

A risk neutral person can go for any option he may feel like, as he is mostly indifferent towards the returns he gets from investing into options.

I will prefer going for option (A), and thus makes me a risk averse person. Option A makes sure that get $10 for sure, and there is uncertianity of going back with just $5 in option b.

2. If it were $10000 for certain:

A rish averse person wil go for option (a), $10000 for certain. A risk averse person is someone who likes to play it safe all the time, he may receive less return but he will always hesitate to go for a risker option and always prefers certainity.

A risk loving person will go for option (b), where if heads comes, he get's $5000 and if tails comes, he gets $15000. A risk loving person is someone who likes to go for increased risk if it is offering a higher return.

A risk neutral person can go for any option he may feel like, as he is mostly indifferent towards the returns he gets from investing into options.

I will prefer going for option (A), and thus makes me a risk averse person. Option A makes sure that get $10000 for sure, and there is uncertianity of going back with just $5000 in option b.

3. If it were $10000for certain:

A rish averse person wil go for option (a), $10000 for certain. A risk averse person is someone who likes to play it safe all the time, he may receive less return but he will always hesitate to go for a risker option and always prefers certainity.

A risk loving person can go for either option (a) or option (b), where if heads comes, he get's $5000 and if tails comes, he gets $15000. A risk loving person is someone who likes to go for increased risk if it is offering a higher return. He may go for option A also, because in this case there are chances of him losing all the money if heads comes in option B.

A risk neutral person can go for any option he may feel like, as he is mostly indifferent towards the returns he gets from investing into options.

I will prefer going for option (A), and thus makes me a risk averse person. Option A makes sure that get $10000 for sure, and there is uncertianity of going back with $0 in option b.