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Chapter 10 The worth of money

Computer Methods in the Geosciences
DOI: 10.1016/s1874-561x(06)80012-x
  • Economics
  • Political Science
  • Psychology


Publisher Summary Probabilities are the integral components of utility. In a risk venture, people are not only cognizant of the financial gains and losses attached to the venture, but are also aware of the probabilities attached to the losses and gains. For most people, losses have greater negative consequences than he positive consequences of equivalent gains. This is risk aversion. Most people are risk averse, but the degree to which people are risk averse varies greatly. College students, with their limited resources, typically are much more risk averse than are venture capitalists. Some people are actually risk seeking rather than risk averse in their outlook—at least over a range. Because different individuals have different attitudes toward risk, a series of utility functions ranging from strongly risk averse can be envisioned through risk neutral to risk seeking. A risk-neutral outlook is identical to a pure expected monetary value (EMV) criterion, where a financial loss is identical to a gain of an equal amount of money in its psychological effect, except that a loss has negative consequences and a gain has positive consequences, regardless of the amount of money at stake. Many individuals and companies exhibit aberrant behavior toward risk. Some may be risk seeking when lesser amounts of money are involved but become strongly risk averse when larger amounts are at stake. Most people who gamble at casinos are risk seeking over only a limited range. One way to determine utility is to analyze decisions that have been made in the past. Another way is to obtain responses to a series of hypothetical investment alternatives in which losses and gains and attached probabilities are specified for alternative outcomes, which assume that the responses exemplify those that would be obtained in actual situations. Sometimes the responses are so erratic that it is difficult to graph them.

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