Misunderstood activity pertaining to Project Risk Management
Risk tolerance classifications in Project Risk Management
Students often find it difficult to grasp the concept of the 3 risk tolerance classifications:
1. Risk Averse
2. Risk Neutral
3. Risk Seeker
Traditional explanation
Risk tolerance classifications have been defined in terms of the following 2 functions:
a) Utility– The extent of satisfaction gained/ comfort displayed in taking a certain degree of risk
b) Potential Risk/ Pay-off/ Stakes– The degree of Risk and potential benefits involved
The three tolerance classifications have been defined in terms of the rate at which the Utility increases with the increase in potential Risk/ Pay-off.
“Risk Averse” stakeholders display a decreasing rate of growth in the utility, as the stakes increase. The curve soon flattens out when plotted on the graph, with utility increase shown on the y-axis and stakes increase shown on the x-axis.
“Risk Neutral” stakeholders display a constant/ flat rate of growth in the utility, as the stakes increase. The trend line is almost a straight line.
“Risk Seeker” stakeholders display an increasing rate of growth in the utility, as the stakes increase. The trend line is an exponentially rising curve.
The above explanation is little complex to understand for many students, leading to misunderstanding.
Proposed simpler explanation
I have figured out an easier explanation of the 3 classifications, while still being logical. The following 2 functions will be used:
a) Tolerance: Capacity to take Risk
b) Appetite: Willingness to take Risk
Using the above 2 functions, the 3 classifications could be defined with a much simpler explanation.
“Risk Averse” stakeholders limit their Risk Appetite below their Risk Tolerance levels.
“Risk Neutral” stakeholders limit their Risk Appetite equal to their Risk Tolerance levels.
“Risk Seeker” stakeholders display Risk Appetite beyond their Risk Tolerance levels.
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