Risk aversion is often talked about in the world of finance, but according to economic prospect theory it is only half the story.

The other half is the other way around when people face the prospect of loss, they display a risk preference in that they hope to avoid the loss. They seek risk; they are willing to pay for risk. In a well-known example, suppose you are offered the following options:

A. Get $30,000 for sure.

B. Take an 80 percent chance on $40,000 with a 20 percent chance of getting nothing.

What do you choose? If you are like most people, you will choose A. We know that, on average, B is the better choice. The value of option B on average is $32,000. But we don't live our lives on average. Averages are not so interesting when you can only choose once. Most of us are willing to give up some potential gain in order to eliminate risk. This is something we all know. Thus, on average we get $30,000. We gladly pay $2,000 to avoid risk.

Now consider the following two options:

A. Lose $30,000 for sure.

B. Take an 80 percent chance of losing $40,000 with a 20 percent chance of losing nothing.

Now what do you do? Faced with this choice, the great majority of people prefer option B.

Thus, on average we lose $32,000. This time around we gladly pay $2,000 for the risk.

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