In investment, there is often a discussion of risk. Investors are told to assess their own risk tolerance, funds and derivatives often advertise their own expected risk, and brokers ask for your risk tolerance both when opening accounts and for their screening/recommendation engines.
Confusingly, it seems that in these situations risk is measured using very ambiguous language: People speak of "high risk" or "low risk" or even "moderate risk". It seems that I am also expected to quantify my own risk in these terms, yet it's unclear what these terms even mean.
Presumably "high risk" means "you could lose all your money". But that isn't very helpful without a likelihood of the loss happening - for instance, the US Government could declare bankruptcy and I could lose all the money I put in treasury bills, but obviously few would call t-bills a high risk investment.
It appears that some sort of calculation is done (involving at least a histogram of loss magnitude vs. likelihood), and then the results are mapped onto these subjective categories like "high", "moderate" and "low". The calculation part seems straightforward - there is plentiful literature available on it so I am not asking about that. What I'd like to know is, how does the mapping to these subjective terms happen?
Specifically, what does my broker mean when they say an asset or investment strategy is high risk? What does my ETF mean when they claim in the prospectus to be low risk? How am I supposed to answer a question like "rate your risk tolerance from low to high"?
Addendum on 3/29/2016: Perhaps my confusion stems from the fact that my willingness to take on risk is naturally dependent on expected gain. I know this relationship can be formalized, eg. with the Sharpe ratio. However, this does make the question of risk tolerance more confusing - I will refuse (as any rational person) even very tiny risk for poor Sharpe, and I would strongly consider even very large risk if Sharpe is good. Of course, past Sharpe does not guarantee future Sharpe... So what is the assumed Sharpe ratio for these sorts of questions about risk tolerance?