Tuesday, April 03, 2012

The Expected Return Is Negative Infinity

"Risk Aversion" is about people preferring certainty to risk. You'll take a smaller lower return if it's certain over a somewhat higher average expected return if there's a bit of a gamble involved. Basically, you'd prefer an investment providing a certain return of 3% over one with a 50% chance of 2% and a 50% chance of 4%. And we're not just talking about casino gambling or the stock market, we're talking about basic life choices. You can take that salaried job with health insurance, assuming such things exist anymore, or you can try to start a business, gambling that it will succeed reasonably well and you won't get cancer before you can afford the unaffordable health insurance. If our safety net had a fewer holes, and perhaps more importantly, if we didn't have to worry about health insurance, we could all spend our 20s trying to make it as rock stars, like everyone in Canada does. It isn't risk aversion that's the problem, it's risk. It's the fact that if you take the risky route, there's a non-trivial probability that you are well and truly fucked forever.