6 Risk and Risk Aversion 155     of portfolio returns, as well as the circumstances in which variance is sufficient to measure risk. Appendix B discusses the classical theory of risk aversion.             6.1 RISK AND RISK AVERSION   Risk with Simple Prospects   The presence of risk means that more than one outcome is possible. A simple prospect is an investment opportunity in which a certain initial wealth is placed at risk, and there are only two possible outcomes. For the sake of simplicity, it is useful to elucidate some basic con- cepts using simple prospects.1 Take as an example initial wealth, W, of $100,000, and assume two possible results. With a probability p .6, the favorable outcome will occur, leading to final wealth W1 $150,000. Otherwise, with probability 1 p .4, a less favorable outcome, W2 $80,000, will occur. We can represent the simple prospect using an event tree:   W1 $150,000     W $100,000 p .6     1 p .4           W2 $80,000   Suppose an investor is offered an investment portfolio with a payoff in one year de- scribed by a simple prospect. How can you evaluate this portfolio? First, try to summarize it using descriptive statistics. For instance, the mean or