Risk Aversion

There are various definitions of this in economics. That most frequently met is the definition from expected utility theory: the extent to which a sure and

Risk-neutral 303

certain outcome is preferred to a risky alternative with the same expected value. It is an implication of diminishing marginal utility of income. If people had a constant marginal utility of income they would be risk-neutral and, if an increasing marginal utility, risk-loving. In the finance literature on capital pricing, a quite different concept of risk aversion is used, in which people are classified as risk-averse if, for a given expected return, they prefer a portfolio with a smaller variance. See Insurance for an account of the way the diminishing marginal utility of income produces risk aversion.

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