Mastering The Market Cycle – Getting the odds on your side : [PDF Download]

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“Let’s suppose a logical investor is offered two investments with the same expected return, but in one case the return is virtually assured and in the other it is highly uncertain. We would expect him to choose the former, since most people prefer certainty over uncertainty.

If a Treasury bond and a high-tech startup both seemed likely to return 7%, for example, the vast majority of people would go with the Treasury.

Why take the extra risk associated with the startup if no potential increase in return is offered to compensate for the incremental risk? Well, that’s the point: most people would prefer a sure 7% over a possible 7%. In other words, most people are risk-averse.

That’s the essential assumption that underlies the “Chicago school” of finance. To describe risk aversion, I say most people prefer safety and disprefer risk—even though I’ve never seen the word “disprefer” in a dictionary.

(There’s a big difference of opinion regarding the propriety of that word, with the linguistic establishment railing against it, but I think it’s a great word. If it doesn’t exist, it should.)”

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