Inspired by comments in this thread I realized the following about myself. If I were presented with the following choice:
A. $500,000
B. $10,000,000 only if I answer correctly a simple arithmatic question (question not to be worded in any tricky fashion, I have all the time and paper and pencil I would like),
I would pick A. $10,000,000 is a hell of a lot more money than $500,000, and the chance of my answering the question wrong if I choose B is so small as to nearly approach zero. But I’d take the half a million, nevertheless. To me, it’s just too depressing to think about how awful it would be were I to try for the ten million and somehow lose, thereby missing a sure shot at half a million.
Is there any relatively objective way to determine how risk-averse one ought to be?
It occurs to me that if the numbers differed, my feeling would be different. For example if the choices were
C. $500
D. $10,000, with the same conditions as B above,
I’d pick D without hesitation. So perhaps a very rich person would see A/B above similarly to the way I see C/D here?
Well anyway… How would you pick? (In each case, or in any other case you can come up with which you think informative to the issue?) And what else do you think about the questions I raise here?
It seems like you are really averse to regret. You think you can handle regretting 10,000 but 500,000 would be more regret than you can handle. I think you should measure the risk by the odds and deal with the fear of regret as a separate thing.
I’d probably pick B and D if the odds were that slim that I’d lose. I’m pretty risk averse but I’m not that afraid of regrets just because my experience has been that I will accept my own lost opportunities and mistakes pretty quickly and do a darn good job of rationalizing. At the same time, I would be more averse to gambling something I already have. In these examples I’m gambling a sure thing but I haven’t put that money in my bank account yet so it’s not really mine. I’m not attached to it.
Your OP has no real risk at all. Either way, you lose nothing. If your example is the riskiest you are willing to be, then your level of risk aversion is 100%.
Not to say that’s a bad thing.
I’m not sure how this fits in but I’ll share this story. Years ago I attended a lecture series on entrepaneurship – including speakers like Mary Kay (cosmetics) and Anton(?) Bose, the sound system guy. There were 7 or 8 of them of that caliber, and almost all of them shered a really scary trait, IMO.
They were willing to risk their families’ money to pursue their dreams. Their parents, or spouses, or siblings mortgaged and re-mortgaged their homes or put up their life savings to provide the initial cash.
Maybe this makes them smart, but I was totally appalled. Can you imagine putting your parents’ retirement money on the line for a new brand name of makeup? It’s one thing to risk your own money on your own dream, but to take that risk with your family is unacceptable. And frankly, doing the same with strangers’ money doesn’t do much for me either.
I don’t see the distinction between risk and regret being made in the first (and implicitly in the second) reply. Opportunities can be goods, which moreover can be gained and lost. By choosing B, I would thereby risk the opportunity to posess 500,000 dollars. Another way to put this might be to say that I risk incurring regretful feelings. Either way, what I’m averse to is risk.
This is much like the climactic point of the new game show, Are You Smarter Than a Fifth Grader? except you only get $1,000,000 if you answer the question right. Everybody walks with $500,000, because it’s a sure thing. And most of the questions really are pretty easy, but every once in a while you run into a stumper, which adds enough risk to the equation to make going for the $1 mil a pretty dumb move.
If the question was really guaranteed to be as easy as you claim, and it was arithmetic rather than say, a random piece of knowledge, then yes, I would go for the $10 mil. But in the former example (the actual game show), I would definitely keep the $500,000.
It most certainly does. He has a guaranteed $500,000 that he stands to lose if he answers the question wrong.
FWIW – I’m not wealthy, but I don’t see $500,000 as a lot of money. $10M, you’re through working, and you’re a member at the nicest golf course in town. I’d give it a shot. $1M, I’m not so sure.
With a question like the OP’s, you get into the territory where “utility of money” meshes with “risk aversion”.
I repeat – there is no risk at all in either OP choice. Risk involves the possiblity of loss, not the possibility of gaining some amount, or more than some amount.
There would be a risk if they gave you the half million, and asked you to bet it against the 10 million dollar question. That is not the case here.
