Risk and the utility of wins and losses

I've been reading Against the Gods by Peter Bernstein, which is about risk and how people have learned about probability, how to measure risk, and to some extent control it or use insurance to relieve it.

According to him, it was a man named Bernoulli who first articulated the idea of utility -- that is, that individual people put different emotional values on outcomes. A previous ancient writer said that people should not be so afraid of being struck by lightning, since it happened so rarely. Bernoulli said that people just put a higher emotional importance on the risk of being struck by lightning than of other, more common, dangers.

And Bernstein points out that human life would be a lot less rich if there weren't people who put a lot more value on the reward of taking a risk than they did on the loss they'd suffer from failing. Those are entrepreneurs, explorers and other pioneers who set out to accomplishment something (often at great cost) that is unlikely but which could bring great wealth.

It also explains why I play the lottery. The purely numbers-oriented people say, "The odds are 75 million against you, it's a scam." But I put a greater value on the (admittedly, highly unlikely) wealth I could win than the $2 I lose by playing.

If I didn't play, that $2 would just be absorbed into my daily cash budget, so it has a low utility to me. But I wouldn't have the right to dream of what I'd do if I won.

And who knows? Maybe someday I win. I know the odds are against me, but somebody eventually wins all the money. As long as I have a ticket, it could be me.

If someone has to beg for change on a streetcorner, then they should spend that $2 on the food they need to survive.

If you're depending on the lottery to make you wealth, you need to get off your butt and learn how to make, save and invest more money. You need to perhaps buy some government TIPS bonds to help your savings keep up with inflation.

But don't blame the lottery because some people who play it actually should use that $2 for some other purpose, or because they're too lazy or unambitious to work for wealth in other, more certain ways.

utility and risk
utility and risk