Thursday, January 30, 2014

A thought on risk aversion

There is an article in The Economist on risk, pointing out that people tend to be risk adverse. If you ask people whether they would rather have $50 in hand, or a ticket to a lottery that would pay $120 half the time or nothing the other half of the time, most would prefer to take the cash. This is in spite of the fact that if you had the bet many times, one would do a lot better taking the odds. (Ask any casino owner; they make mints of money with much more modest odds in their favor.)

The article also notes:
Upbringing, environment and experience also play a part. Research consistently finds, for example, that the educated and the rich are more daring financially. So are men, but apparently not for genetic reasons. Alison Booth of Australian National University and Patrick Nolen of the University of Essex found that teenage girls at single-sex schools were less risk-averse than those at co-ed schools, which they think may be due to the absence of “culturally driven norms and beliefs about the appropriate mode of female behaviour”. 
People’s financial history has a strong impact on their taste for risk. Looking at surveys of American household finances from 1960 to 2007, Ulrike Malmendier of the University of California at Berkeley and Stefan Nagel, now at the University of Michigan, found that people who experienced high returns on the stockmarket earlier in life were, years later, likelier to report a higher tolerance for risk, to own shares and to invest a bigger slice of their assets in shares.
It has long been my opinion that we should do simulations of markets assuming that attitudes toward risk are randomly distributed. That seems intuitive to me. Consider parimutual betting at a race track; some people would rather bet on a longshot others on a favorite, the betting is not simply due to differences in estimation of the odds on winning. 

No comments: