Tolerance For Risk

FIGURE 17-2. Risk preference and the utility function.

The shape of a given decision-maker's curve is derived from comparing response to alternative decision acts.

FIGURE 17-2. Risk preference and the utility function.

The Y axis in Figure 17-2 represents "utility," which can be defined as the amount of satisfaction or pleasure that the individual receives from a payoff. (This is also called the project manager's tolerance for risk.) The X axis in this case is the amount of money at stake.

With the risk averter, utility rises at a decreasing rate. In other words, when more money is at stake, the project manager's satisfaction or tolerance diminishes. With a risk neutral position, utility rises at a constant rate. With the risk lover, the project manager's satisfaction increases when more money is at stake (i.e., an increasing slope to the curve). A risk averter prefers a more certain outcome and will demand a premium to accept risk. A risk lover prefers the more uncertain outcome and may be willing to pay a penalty to take a risk. While the project manager's (or other key decision-maker's) tolerance for risk may vary with time, different representations of this tolerance (e.g., risk averter and risk taker) should not exist at the same time or inconsistent decisions may be made.

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Project Management Made Easy

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