Risk Aversion

Risk aversion is the preference for a certain outcome over a probabilistic outcome with the same expected value. It is not merely a psychological tendency but a structural feature of utility functions that are concave in wealth: the disutility of a loss is greater than the utility of an equivalent gain. The concept was formalized by Daniel Bernoulli in 1738 and became central to expected utility theory, but its most important challenge came from the Allais Paradox, which showed that people's aversion to risk is not uniform — it intensifies dramatically when certainty is involved. The certainty effect cannot be captured by any smooth concave utility function. Risk aversion is not one thing; it is a family of responses to different kinds of uncertainty, and the attempt to compress them into a single parameter has been one of the persistent failures of neoclassical economics.\n\n