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Low-hanging fruit: Incredible comment chain on /r/NBA in which people misunderstand the definition of risk and get upvoted then downvoted later on
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https://www.reddit.com/r/nba/comments/d4ma3g/comment/f0e5gm0

Context: someone bet $10 on Ricky Rubio, a role player in the NBA, winning the World Cup MVP. Rubio won WCMVP, and thus the person won $1000 due to the odds.

So let's get to the bad econ/finance.

First, as a note, "risk" is something that can be interpreted in different ways in daily conversation, so normally I'd let it slide, but in this conversation people seemed to be arguing over the established financial definition of risk. So this is a bit of low-hanging fruit, but if someone can learn from this then I'll be satisfied.

"Dang that’s the literal definition of low risk high reward"

This is 48 as of right now, and it's not really correct. Risk is about probabilities, in this case the probability that the guy would lose the bet and, as such, his original investment of $10. Betting $10 on Rubio had a low cost and high reward, but certainly a high risk since the USA was originally favored to win the World Cup.

"No it’s not, USA were the favourites to win and get the MVP."

-24 as of right now.

"He bet 10 bucks and got 1000. Thats definition of low risk high reward"

Let's attack this with a graphical approach. Take a look at this exquisitely painted risk aversion graph by yours truly. The vertical axis is utility, the horizontal axis is income, and the green line between the orange dots measures probability that would dictate the expected income on the horizontal axis. Since Ricky Rubio had 100 to 1 odds of winning World Cup MVP, the probability point on the green line would be extremely close to the left orange dot. There is the potential for high reward, of course, but the probability indicates that our guy was most likely not going to reap that high reward.

That is risk: the probability. Low risk would mean that the point on the green dot would move closer to the right orange dot (which would, correspondingly, move closer to the left since if Rubio had high odds of winning WCMVP, more people would be inclined to bet for him, and bookies don't want to be paying out tons of bets times two orders of magnitudes). The loss of $10 only indicates a low relative cost.

To provide a more intuitive example, say you decided to start investing. Let's say you could invest $100 in a relatively safe mutual fund, or invest $100 in my future NBA career. If either investment fails, you lose that $100. Are the risks the same? Obviously not (on the graph, the point on the green line for my NBA career would be firmly on the left orange dot, while the point would be somewhere to the right of that for the mutual fund), but that's what's being implied when one conflates the potential loss with risk.

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5 years ago