Risk Appetite and Risk Attitude
Riskczar writes about differing risk appetites this week.
I want to introduce a nuance to his discussion. He mentions that his risk appetite is less than both his brother and his significant other.
The Risk Doctor presents a view of risk attitude that tracks directly with what Trevor calls differing risk appetites. They both look at it as a spectrum of higher risk appetites to lower. David suggests that anyone with a higher risk appetite has one risk attitude while someone with a lower risk appetite has another risk attitude. Which is consistent with the digestive term appetite that is used.
However, another way of looking at this is possible and is suggested by the Plural Rationalities approach to risk that is often featured here on Riskviews.
With the Plural Rationalities approach, it is suggested that folks with an apparent higher risk appetite may well simply perceive that there is less risk than someone with a lower risk appetite. The people who perceive that risk is very high are called Conservators. The people who perceive that risk is very low are called Maximizers and the people who perceive that risk is moderate are called Managers. Finally Plural Rationalities suggests that there is a fourth risk attitude that is possessed by folks who just do not think that they can know how risky that something really is. They are called Pragmatists.
These Pragmatists do not fit onto the spectrum of risk appetites. However, plenty of these people exist. They are the undecideds in the polls about risk. They do not feel that the future is highly predictable, so they choose not to try. They therefore seem to be less convinced about likelihood of favorable outcomes as well. Or lack of likelihoods either. Lottery tickets are appealing to some Pragmatists. Pragmatists may take on situations that are seen to be high risk by the Conservators and pass up on situations that are seen as low risk to the Maximizers. Pragmatists are also often frustrating to the Managers because they fail to follow the logical conclusions reached by the Managers.
But Pragmatists are well suited for the situation that seems to have settled over many economies in the world in the recent past. The Uncertain economy. Modern economics does not even officially have that as a phase of an economic system, though some economists have repeatedly described the current situation with that exact word. Their approach the the Uncertain economy is to try to get it to change into one of the other stages that they do think that they understand.
So the Maximizers and Conservators are not choosing more risk or less risk as the Rational Expectations theory suggests, they are actually believing that the world is less risky (Maximizers) or more risky(Conservators).
They are not acting irrationally, they are acting according to their own rationality.
This would be irrational, except for the fact that in some periods of time, they are correct.
Once they start to notice that their view of risk is no longer correct, slowly but surely they eventually change their risk attitude to adjust to the current reality.
This process explains the market cycles without having to assume irrationalities. Instead we need to acknowledge Plural Rationalities.
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