Investors who are less risk averse will have what type of utility curves? A) Flatter. B) Inverted. C) Steeper. the answer is A , I answered C based on the fact that a less risk averse investor would require more return to compensate him/her for taking more risk making the slope of the indifference curve more steeper, what do u think ?
If the investor is less risk averse, it means that he requires a relatively small additional compensation in form of return for taking more risk --> the utility curve is flatter than the one of a more risk averse investor would be.
I understand this , but I thought of a more steeper curve as a motive for the investor to undertake more risk in terms of higher return.
Well, I guess, if you are risk-friendly, it means you like risk and then you don’t need any special motivation to take it :).
A risk averse person, necessarily, has diminishing marginal utility from income; They get less usefulness from each extra dollar of income (or stuff). This is evidenced by the fact that a risk averse person would rather remain at their current income level than risk a dollar to gain a dollar (in a 50/50 gamble). So the utility curve (drawn on a graph with Utility on the X axis and Income on the Y axis) of a risk averse person has to “curve” downward: It’s slope must decrease as we move along it towards higher income levels. If you drew a tangent on this curve, it would only touch on one point. If it touched in two, it would represent an even-money gamble that this supposedly risk averse person would be willing to make. A completely risk neutral person would be indifferent between making an even money “dollar for a dollar” gamble at any income level. They must value each additional dollar of income the same as the last one. This means their utility curve must be straight; it must have the same slope everywhere. A tangent drawn on it would touch everywhere; they are indifferent. So the more curved the utility function is, the less a person values the next dollar of income compared to the last and the more risk averse they must be (unwilling to make an even-money gamble).
Unless it’s curved upwards, indicating “risk preference.” So what matters is the ratio of how much they value the next dollar to the last.
I see , thanks alot for all the explanations mihau10 , ur second post made me realize how stupid am I…