The Notion of Risk and Probability

This chapter introduces the concept of risk. Many definitions have been offered to explain what is meant by risk in the literature. Notion of probability is described and differences between classical (or mathematical) probability, statistical (or frequentist) probability and subjective probability are explored. The information asymmetries between the insurer and the insured are defined. The reader can learn the definition and examples of adverse selection; morale hazard and moral hazard. In the paragraphs, it is explained that everyone has their own risk appetite. Based on to the utility function of Von Neumann–Morgenstern it is possible to determine the behaviour of individuals according to their attitude towards the benefit/result obtained. Behavioural finance and cognitive psychology on decision-making processes in conditions of uncertainty shown how often the consumer, in complex situations, makes choices based on simplified judgement mechanisms.