Pure Risk and Speculative Risk

In the field of risk management, risks are often divided into two main categories.  These are called “pure risks” and “speculative risks.”

Basically both terms refer to bad things that can befall one.  But they can be distinguished.

A pure risk is something that will necessarily be bad if it happens.  There is the possibility of loss or no loss, with no possibility of gain.

Imagine you are being held captive by a sadistic terrorist who decides to submit you to a form of Russian roulette.  He puts a bullet in a gun that holds six bullets, spins the cylinder, points it at your head, and pulls the trigger.

There is a one in six risk that you will be shot in the head.  There is no corresponding good outcome.  The only “good” outcome would be the absence of the bad outcome.  Thus, this is a pure risk.

Pure risks tend to be out of the person’s control, in that people, unless they’re suicidal, do not intentionally put themselves in a situation that is all downside and no upside.

Pure risks can be personal (being sickened by an explosion at a chemical plant a few miles down the road), property (having a tornado wipe out your house), or legal (being sued because someone claims something you posted on the Internet constitutes hate speech).

Speculative risks, on the other hand, are gambles.  Speculative risks are the downside of choices one knowingly makes that also have upside.

Having sex with an intriguing stranger is a speculative risk.  You might have the best sex of your life, you might fall in love, you might so impress the person with your prowess that they name you the sole beneficiary in their will, die the next day, and turn out to be a billionaire.  On the other hand you might get an STD, the sex might result in an unwanted pregnancy, there might be a hidden camera present that will be used to blackmail you, you might fall for the person and get your heart broken, etc.

Playing poker is a speculative risk.  You risk losing some or all of the money you bring to the game.  But it’s not a pure risk because, one, you could also win, and two, you take on this risk knowingly and intentionally.

Investments are the classic case of speculative risk.  You might end up behind, but you also might end up ahead.

There are degrees of speculative risk.  If you invest in U.S. Savings Bonds, and if you invest in the most volatile of junk bonds, both involve speculative risks that you will lose your money, but they are not thereby equal.  In the first case, the chances of that loss occurring are very close to zero.  In the second case, the chances of that loss occurring are fairly high.