HKSM
Risk Neutral
In utility theory, a risk-neutral stakeholder is neither risk averse nor risk seeking; choices are made on expected value alone, without being swayed by how risky one option is compared with another.
Key Points
- Neither risk averse nor risk seeking; indifferent to variability in outcomes.
- Utility function is effectively linear; decisions follow expected monetary value (EMV).
- Chooses among alternatives based on average payoff, not the spread or volatility.
- Contrasts with risk-averse (prefers certainty) and risk-seeking (prefers higher variance) behaviors.
Example
A sponsor must choose between: Option A, a guaranteed $100,000 benefit; and Option B, a 50% chance of $220,000 and a 50% chance of $0 (EMV = $110,000). A risk-neutral decision maker selects Option B because it has the higher expected value, despite greater uncertainty.
PMP Example Question
Which statement best describes a risk-neutral stakeholder in project selection?
- Prefers lower-variance outcomes even if the expected value is smaller.
- Chooses based solely on expected value, regardless of outcome uncertainty.
- Always selects the option with the highest possible payoff.
- Avoids uncertain options to protect the baseline at all costs.
Correct Answer: B — Chooses based solely on expected value.
Explanation: Risk-neutral behavior evaluates alternatives by their expected value and is indifferent to how risky one scenario is compared with another.
