Risk is Relative

In the New York Times, Virginia Postrel had an interesting article on risk. She notes the work of Professor Shane Frederick of MIT who’s studied how people have different conceptions of risk. Risk truly is in the eye of the beholder.
Professor Frederick devised a simple math test in which all the answers are counter-intuitive. He found a very strong correlation between test answers and a person’s perception of risk.

“Even when it actually hurts you on average to take the gamble, the smart people, the high-scoring people, actually like it more,” Professor Frederick said in an interview. Almost a third of high scorers preferred a 1 percent chance of $5,000 to a sure $60.
They are also more patient, particularly when the difference, and the implied interest rate, is large. Choosing $3,400 this month over $3,800 next month implies an annual discount rate of 280 percent. Yet only 35 percent of low scorers — those who missed every question — said they would wait, while 60 percent of high scorers preferred the later, bigger payoff.
Men and women also show different results. “Expressed loosely,” he writes, “being smart makes women patient and makes men take more risks.”

You can see Professor Frederick’s original article here.

Posted by on January 30th, 2006 at 10:34 am

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