1 Risk aversion
1.1 A note about terminology
We begin with a ‘health warning’ about terminology, this time about the use of the word ‘risk’ in finance.
The difference between the everyday and the specialised meanings of ‘risk’ is less technical and more radical than in the case of ‘return’. In everyday usage, ‘risk’ is negative – the risk of having a car accident or the risk of losing one's job. If we use ‘risk’ in a positive sense at all, it is only as a result of adopting a consciously ironic tone: ‘There's not much risk of my winning the lottery this week.’ But in the language of finance, ‘risk’ is neutral and refers purely to the possibility that a particular outcome will be different from (that is, either worse or better than) either a single expected outcome or the probability-weighted mean of many possible outcomes. In other words, in financial language ‘risk’ is the same as ‘uncertainty’.