Spotlight:Be Risk Averse, Not Loss Averse

Risk aversion is different from loss aversion, and investors who understand this are the ones who succeed.

On April 10, 2003 soft drink company Pepsi announced a contest called “The Pepsi Billion Dollar Sweepstakes”. It was supposed to run from May 1, 2003 to September 14, 2003.

For the contest, Pepsi printed one billion special codes, which could be redeemed either on their website or via postal mail. Of all the codes redeemed, which Pepsi estimated to be 200 – 300 million, 100 were chosen in a random draw to appear in a two-hour live gameshow-style television special. Each person was assigned a random 6-digit number, and a chimpanzee (to ensure a truly random number and of course to rule out any monkey business) backstage rolled dice to determine the grand prize number. This number was kept secret and the 10 players whose numbers were closest to it were chosen for the final elimination. On the evening of September 14, the final day of the contest, the event, titled Play for a Billion, was aired live. If a player’s number matched the grand prize number, he would win US$ 1 billion.

Given the scenario, it was highly unlikely that anyone would win a billion dollar. The chances were literally 1 in a billion. Inspite of that, Pepsi was unwilling to bear the risk of the possible billion-dollar prize. So they arranged for an insurance company to insure the event. They paid US$ 10 million premium to Berkshire Hathaway to assume the risk.

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