What is the difference between absolute and relative risk aversion?

What is the difference between absolute and relative risk aversion Introduction: The Significance of Risk Assessment Hello, everyone! When it comes to making decisions, especially in the realm of investments and financial planning, understanding risk is crucial. Today, we'll delve into two important risk assessment measures: absolute and relative risk aversion. By the end of this video, you'll have a clear grasp of their distinctions and how they impact decision-making. Defining Absolute Risk Aversion To start, let's focus on absolute risk aversion. This concept refers to an individual's inherent inclination to avoid risk, regardless of the potential reward. In other words, someone with high absolute risk aversion would be extremely cautious, even if the potential gains are significant. On the other hand, an individual with low absolute risk aversion might be more willing to take on risk, as long as the potential rewards are substantial. Understanding Relative Risk Aversion Now, let's shift our attention to relative risk aversion. Unlike absolute risk aversion, this measure considers the ratio of the potential reward to the individual's wealth or resources. It's a more nuanced approach, as it takes into account the individual's current financial situation. For example, someone with high relative risk aversion might be more willing to take on risk if their wealth is already substantial, as the potential loss wouldn't have a significant impact on their overall financial well-being.