Glossary
Risk aversion and risk tolerance
What are risk aversion and risk tolerance?
Risk aversion means preferring a certain amount to a gamble with the same expected monetary value. Risk tolerance describes how willing someone is to accept risk.
A simple example
You can take a guaranteed $50 or choose a 50/50 chance of getting $100 or nothing. Both options have an expected value of $50. Choosing the guarantee is consistent with risk aversion in that choice.
Two explanations of risk attitudes
Expected-utility theory
In expected-utility theory, choices depend on the utility of possible outcomes and their probabilities. A concave utility function for wealth means that another dollar adds less utility at higher wealth levels; this can make the certain $50 preferable to the equal-value gamble above.
Prospect theory
Prospect theory instead evaluates gains and losses relative to a reference point and allows decision weights to differ from objective probabilities. It can therefore explain changes in risk attitudes when an outcome is represented as a gain or a loss.
A gain-and-loss illustration
Imagine a person choosing a certain gain of $50 over equal chances of gaining $100 or nothing, but choosing equal chances of losing $100 or nothing over a certain $50 loss. Each pair has equal expected monetary value: $50 for gains and −$50 for losses. Those choices would show risk aversion in the gain pair and risk seeking in the loss pair. This is an illustrative pattern, not a report of how most people answer these exact questions.
Why context matters
Tversky and Kahneman's research describes risk attitudes that change with the way outcomes are framed and with their probabilities. Common patterns of risk aversion for gains and risk seeking for losses can reverse for low-probability outcomes.
One gamble does not tell you how someone approaches every risk. The stakes, possible outcomes, probabilities, and setting all matter.
Why risk attitudes matter
Choices about insurance, money, or medical outcomes can involve different stakes and different kinds of uncertainty. In each setting, ask which outcomes are possible and how much risk the person is willing to accept. A label taken from an unrelated gamble is not enough.