Bitesize | How To Model Risk Aversion In Pricing?
Show notes
Today's clip is from Episode 152 of the podcast, with Daniel Saunders.
In this conversation, Daniel Saunders explains how to incorporate risk aversion into Bayesian price optimization. The key insight is that uncertainty around expected profit is asymmetric across price points, low prices yield more predictable (if modest) returns, while high prices introduce much wider uncertainty. Rather than simply maximizing expected profit, you can pass profit through an exponential utility function that models diminishing returns, a well-established idea from economics.
This adds an adjustable risk aversion parameter to the optimization: as risk aversion increases, the model shifts toward more conservative price recommendations, trading off potentially large but uncertain gains for outcomes with tighter, more reliable distributions.
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