Copyright

Risk Aversion: Definition, Principle & Example

Risk Aversion: Definition, Principle & Example
Coming up next: What Is Accounting? - Purpose, Importance & Relationship to Business

You're on a roll. Keep up the good work!

Take Quiz Watch Next Lesson
 Replay
Your next lesson will play in 10 seconds
  • 0:01 Overview of Risk Aversion
  • 0:48 Definition of Risk Aversion
  • 1:15 Risk Averse Behaviors
  • 2:10 Examples
  • 3:42 Lesson Summary
Add to Add to Add to

Want to watch this again later?

Log in or sign up to add this lesson to a Custom Course.

Log in or Sign up

Timeline
Autoplay
Autoplay
Speed

Recommended Lessons and Courses for You

Lesson Transcript
Instructor: Brianna Whiting
In this lesson, we will look at the term risk aversion. We will look at what it means to be a risk averse person and examine an example. The lesson will then be wrapped up with a summary and a quiz.

Overview of Risk Aversion

We are all familiar with the website known as Craigslist. There, you simply type in what you are looking for and see if anyone has one for sale. This website also allows someone to sell items they may no longer want instead of throwing them away. In doing so, the seller has a chance to earn money for the items they no longer want.

So, let's imagine you have a couch you no longer need. Rather than throwing it into the dumpster, you decide to try and sell it on Craigslist. After a few weeks of no response, a gentleman offers you $20 less than your asking price. You then need to consider should you hold out for your asking price and risk not selling the couch at all, or should you take a loss and guarantee yourself some amount of money? What you have just been a part of is the concept of risk aversion.

Definition of Risk Aversion

So what exactly is risk aversion? Well, it's a concept where an individual is faced with uncertainty, and they must decide how they will react to that uncertainty. For example, when it comes to investments, an individual may prefer to go with the investment that has the lowest risks even though it may not bring in the most return. Those individuals that tend to turn away from the uncertainties and risks are known as risk averse individuals.

Risk Averse Behaviors

We now know what risk aversion is, but let's look a little deeper at an individual that falls under this category, otherwise known as an risk averse individual.

For starters, risk averse people, do not like risks. They do not like the uncertainties that surround the risk no matter how big the payoff could be.

Second, risk averse people are often investors looking to make the best investment. This often means a possible lower payoff with known risks in order to avoid higher or unknown risks.

Lastly, even though some investments result in higher payoffs, such as those in the stock market, a risk averse investor would rather get a definite return, such as investing in government bonds. The bottom line is: while the stock market could pay off in a big way, not knowing how things will turn out is too much of a risk for someone who is a risk averse investor.

Examples

Let's now use game shows as an example to explain the term risk aversion a little more.

Carol and her husband Bob won tickets to a game show that will be airing in their hometown. After watching numerous episodes of the popular show, both Carol and Bob understand that the concept of the show is to take risks in order to win more prizes.

To unlock this lesson you must be a Study.com Member.
Create your account

Register to view this lesson

Are you a student or a teacher?

Unlock Your Education

See for yourself why 30 million people use Study.com

Become a Study.com member and start learning now.
Become a Member  Back
What teachers are saying about Study.com
Try it risk-free for 30 days

Earning College Credit

Did you know… We have over 200 college courses that prepare you to earn credit by exam that is accepted by over 1,500 colleges and universities. You can test out of the first two years of college and save thousands off your degree. Anyone can earn credit-by-exam regardless of age or education level.

To learn more, visit our Earning Credit Page

Transferring credit to the school of your choice

Not sure what college you want to attend yet? Study.com has thousands of articles about every imaginable degree, area of study and career path that can help you find the school that's right for you.

Create an account to start this course today
Try it risk-free for 30 days!
Create An Account
Support