BERNOULLI'S HYPOTHESIS

Hypothesis proposed by mathematician Daniel Bernoulli that expands on the nature of investment risk and the return earned on an investment. Bernoulli stated that an investor's acceptance of risk should incorporate not only the possible losses that can occur, but also the utility, or intrinsic value, of the investment itself.

Also known as the "expected utility hypothesis".

Related closely to the idea of diminishing marginal returns, Bernoulli's hypothesis essentially states that one should not accept a highly risky investment choice if the potential returns will provide little utility, or value. A young investor who still has his or her highest income-earning years ahead can be expected to accept greater investment risk, as the potential returns could be very valuable compared to such a person's relative lack of wealth. On the other hand, a retired investor with ample savings already in the bank should not be looking for a highly volatile or risky investment, as the potential benefits are unlikely to be worth the risk.