Professionals find it difficult to differentiate Risk Appetite and Risk Tolerance. Some use the terms “risk appetite” and “risk tolerance” interchangeably. The PMBOK® guide explanation can be confusing to readers and different definitions abound.
Let’s look at how the PMBOK® Guide, Fifth Edition defines the terms:
Risk Appetite – “The degree of uncertainty an entity is willing to take on in anticipation of a reward.”
Risk Tolerance – “The degree, amount, or volume of risk that an organization or individual will withstand.”
Please, share your examples of each. Saving Changes...
Senior Projects Manager | Field & Marten AssociatesNew Westminster, British Columbia, Canada
Mauro,
It is not very confusing if you look at it this way:
Risk Appetite is how much you believe you'd like to risk but then comes the Risk Tolerance where you can see if your Appetite is within your tolerance or not.
For example: You'd like to eat two apples (Appetite) but you're limited to one due to your sugar intake limitations (Tolerance) so you are going to eat 1 Apple so while you're still risking your health, it is within the tolerance.
Hope this helps.
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4 replies by Aaron Porter, Br. Ts. PUI CHEE KHIAN, CHRISTIAN SARAVIA MARTINEZ, and Vincent Guerard
Oct 21, 2016 6:09 PM
Aaron Porter
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I like the food analogy.
To add to it, you may have heard the following idiom - your eyes are bigger than your stomach. To apply this to Rami's analogy, your Risk Appetite can be bigger than your Risk Tolerance. What can happen when you eat too much - heartburn, or other intestinal problems. Too much risk...
Personally, I've never used the term Risk Appetite when discussing risk. I have used the term Risk Aversion when discussing how much or how little risk an entity is willing to accept.
Dec 28, 2017 8:35 AM
Br. Ts. PUI CHEE KHIAN
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Rami,
This is an awesome food analogy. I never expect the terms could be explained in such a interesting way. You make me a day. Thanks.
It is not very confusing if you look at it this way:
Risk Appetite is how much you believe you'd like to risk but then comes the Risk Tolerance where you can see if your Appetite is within your tolerance or not.
For example: You'd like to eat two apples (Appetite) but you're limited to one due to your sugar intake limitations (Tolerance) so you are going to eat 1 Apple so while you're still risking your health, it is within the tolerance.
Hope this helps.
I like the food analogy.
To add to it, you may have heard the following idiom - your eyes are bigger than your stomach. To apply this to Rami's analogy, your Risk Appetite can be bigger than your Risk Tolerance. What can happen when you eat too much - heartburn, or other intestinal problems. Too much risk...
Personally, I've never used the term Risk Appetite when discussing risk. I have used the term Risk Aversion when discussing how much or how little risk an entity is willing to accept. Saving Changes...
Sergio Luis ConteHelping to create solutions for everyone| Worldwide based OrganizationsBuenos Aires, Argentina
I never use those terms. I ever use Risk Seeking, Risk Averse and Risk Neutral. Saving Changes...
It is not easy for me to clearly differentiate "Risk Appetite" from "Risk Tolerance". However, my understanding to context of PMBOK Guide, I can state both terms as below:
Risk Appetite: Dependent on degree of the benefit from the successful completion of the project, level of exposure to risks which might be accepted by an organization might vary. Higher benefit, higher exposure to risk might be taken. As Aaron and Sergio commented, it might be one of them, a seeker, neutral or averse. So it might be logically correct to say our risk appetite is high as an example of seeker, but it might not be correct that we should not take a measure to any risks because we are a seeker. So there must be risk tolerances to be determined as Rami commented above.
Risk Tolerance: When risk appetite is set up or introduced for the project as seeker, neutral or averse, based on the degree of that exposure to risk which might be taken by an organization, the risk tolerance which might be qualitative or quantitative can be determined in the organization. The determined organization's risk tolerance allows the project to know when they should take appropriate actions to deal with the level of the exposure to risk by reducing probability to occur or impacts when occurs, or by reducing both. PMBOK Guide states many different methods of analysis, strategies or responses to risks based on the project situations and risk tolerance might affect the ways of analysis, type of strategies or responses when the project performs, selects or change. Saving Changes...
"Both risk appetite and risk tolerance set boundaries of how much risk an entity is prepared to accept. Risk appetite is a higher level statement that considers broadly the levels of risks that management deems acceptable while risk tolerances are more narrow and set the acceptable level of variation around objectives.
For instance, a company that says that it is does not accept risks that could result in a significant loss of its revenue base is expressing appetite. When the same company says that it does not wish to accept risks that would cause revenue from its top-10 customers to decline by more than 10% it is expressing tolerance.
Operating within risk tolerances provides management greater assurance that the company remains within its risk appetite, which, in turn, provides a higher degree of comfort that the company will achieve its objectives."
In general, risk appetite relates to the amount and type of risk an organization is willing to pursue.It is the level of risk that aligns with the business strategy. A company with a high risk appetite would accept more uncertainty for a higher reward, while a company with a low risk appetite would seek less uncertainty, for which it would accept a lower return. Example: A target return on investiment of 10 percent denotes a “moderate” Risk Appetite in certain markets; or less than 20% chance that more than 10% of capital will be lost next year.
It refers to the TARGET.
Risk tolerance relates to the amount of risk the organization is willing to endure to achieve objectives — in other words, the limits of a company’s capacity for taking on risk, a boundary on risk-taking.
It refers to TOLERABLE DEVIATIONS from the target. Saving Changes...
Anand ChabadaSENIOR PROJECT MANAGER| Bangkok Mass Transit System Public Company Limited (BTSC)Bangkok, Thailand
The commonality among these calculations, however, is that they represent the absolute maximum loss a company is able to take on.
Risk capacity also should be considered as an important element which indicates how much a company is able to absorb potential losses. For instance, amount of reserves that bank need to pass the stress tests.
A high risk appetite firm will consume a larger portion of risk capacity, and vice versa.
On contrary, risk tolerances are the quantitative thresholds that allocate the firm's risk appetite to specific risk types. Saving Changes...
It is not very confusing if you look at it this way:
Risk Appetite is how much you believe you'd like to risk but then comes the Risk Tolerance where you can see if your Appetite is within your tolerance or not.
For example: You'd like to eat two apples (Appetite) but you're limited to one due to your sugar intake limitations (Tolerance) so you are going to eat 1 Apple so while you're still risking your health, it is within the tolerance.
Hope this helps.
Rami,
This is an awesome food analogy. I never expect the terms could be explained in such a interesting way. You make me a day. Thanks.
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