An investor is said to be risk averse if he prefers less risk to more risk, all else being equal. Portfolio theory tells us that such an investor will require compensation for taking systematic risk. The opposite of risk aversion is risk seeking (sometimes called risk loving). A risk seeking investor prefers more risk to less, all else being equal. There are risks that he will pay to be allowed to take. Financial theories generally assume investors are not risk seeking. However, risk seeking behavior is observable in actual life. People who play lotteries or gamble at casinos accept a negative expected return in exchange for the thrill of financial risk. Between risk aversion and risk seeking is a state called risk neutrality. An investor is risk neutral if he is indifferent to risk. He will neither pay to avoid it nor to take it. In a nutshell, risk does not affect his decisions. Financial theories generally assume investors are not risk neutral. However, risk neutrality plays an important role as a formal tool in option pricing theory.
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