What is Speculative Risk
Speculative risk is a category of risk that, when undertaken, results in an uncertain degree of gain or loss. All speculative risks are made as conscious choices and are not just a result of uncontrollable circumstances. With a speculative risk, there is some chance of either a gain or a loss. Therefore, speculative risk is the opposite of pure risk, which is the possibility of only a loss and no possible gain.
Almost all investment activities involve some speculative risks, as an investor has no idea whether an investment will be a blazing success or an utter failure. Some assets carry a combination of speculative and hedgeable risk, such as an options contract. If you buy a call option, you know in advance that your maximum downside risk is the loss of the premium paid if the options contract expires worthless. At the same time, you do not know what your potential upside gain will be, since nobody can know the future.
BREAKING DOWN Speculative Risk
Some investments are more speculative than others. For example, investing in government bonds has much less speculative risk than investing in junk bonds, because government bonds have a much lower risk of default.
A speculative risk has the potential to result in a gain or a loss. In comparison, a pure risk will only result in loss. Speculative risk requires input from the person looking to take it on and therefore is entirely voluntary in nature. Any investment may be seen as speculative, as most investors will not take on investments that are known to result in losses.
The result of a speculative risk is hard to anticipate, as the exact amount of gain or loss is unknown. Instead, various factors, such as company history and market trends, are used to estimate the potential for gain or loss. Often, these risks may be deemed uninsurable because there is no concrete way to predict the outcome.
Examples of Speculative Risk
Most financial investments, such as the purchase of stock shares, involve speculative risk. It is possible for the share value to go up, resulting in a gain, or go down, resulting in a loss. While data may allow certain assumptions to be made regarding the likelihood of a particular outcome, the outcome is not guaranteed.
Sports betting also qualifies as having speculative risk. If a person is looking to bet on which team will win a football game, the outcome could result in a gain or loss, depending on which team wins. While the outcome cannot be known ahead of time, it is known that a gain or loss are both possible.
Comparison to Pure Risk
In contrast, pure risk involves situations where the only outcome is loss. Generally, these sorts of risks are not voluntarily taken on and, instead, are often out of the control of the investor. Pure risk is most commonly used in the assessment of insurance needs. Should a person damage a car in an accident, there is no chance that the result of this will be a gain. Since the outcome of that event can only result in a loss, it is a pure risk.