Exaggerated risk: Prospect theory and probability weighting in risky choice.

Abstract

This is the unspecified version of the paper.This version of the publication may differ from the final published version. Abdellaoui, 2000;Gonzalez & Wu, 1999;Prelec, 1998;Tversky & Wakker, 1995;Wakker, 2003). Permanent repository linkThe nonlinear impact of probability on decisions is exemplified by the fourfold pattern of risk preferences predicted by Cumulative prospect theory (Tversky & Kahneman, 1992). Thus, because people overweight small probabilities, both low probability gains and low probability losses loom large relative to certain payoffs with the same expected value. This results in risk seeking for gains and risk aversion for losses at low probability -for example, people are tempted to buy lottery tickets (seeking unlikely gains) and insurance (attempting to avoid unlikely losses). Also, as people underweight moderate and large probabilities, they show a contrasting risk aversion for high probability gains and risk seeking for high probability losses compared to certain payoffs with the same expected value. Risky Decision-Making and PrecautionsTversky & Kahneman's (1992) studies reporting under-and over-weighting of probability measured respondents' binary choices between monetary gambles.However, there is some reason to believe that people's choices about monetary gambles may not correspond with their preponderance for risk in situations where they need to consider decisions regarding other kinds of risks. Several studies have reported increased attractiveness of decision prospects when framed as insurance decisions; specifically, there is evidence for a context effect in which prospects presented in an insurance context are judged with greater risk aversion than mathematically identical choices presented as standard gambles (Connor, 1996; EXAGGERATED RISK 5 Hershey & Schoemaker, 1980;Schoemaker & Kunreuther, 1979;Slovic, Fischhoff, Lichtenstein, Corrigan & Combs, 1977). This finding has prompted the suggestion that people have a relatively favorable attitude towards insurance because, unlike gambling, insurance is viewed as an investment as well as a means of risk reduction (Slovic, Fischhoff & Lichtenstein, 1987).Given the suggestion that there may be differences in people's decision behavior as a function of the type of risks they may be contemplating, we propose that there is a need to be sensitive to possibly different psychological types of risky decision.Accordingly, we identify and define precautionary decisions and behavior as those occasions where people aim to minimize or avoid risks by taking protective actions and where the benefits of taking precautions exemplify risk-averse behavior (Baron et al., 2000;Hershey & Schoemaker, 1980). Protective behavior and decisions in the face of risk have been the subject of a number of studies (e.g., Baron, Hershey & Kunreuther, 2000;Huber & Huber, 2008;Johnson, Hershey, Meszaros & Kunreuther, 1993;Kunreuther, 2001;Slovic et al., 1987;Wakker, Thaler & Tversky, 1997) and yet, to our knowledge, no study has attempted to asses the probability-...

Preference Change through Choice

“…One assumption that both economic and many psychological theories of decision-making often take for granted is that people's preferences for decisions under risk are stable constructs that stay constant over time and regardless of task (e.g., von Neumann & Morgenstern, 1947;Brandstätter et al, 2006;Tversky & Kahneman, 1992;Tversky & Koehler, 1994; but see Kusev, Van Schaik, Ayton et al, 2009;Stewart, Chater & Brown, 2006;Ungemach, Stewart & Reimers, 2011). For example, one of the main predictions of Cumulative Prospect Theory (Tversky & Kahneman, 1992) is the so-called four-fold pattern of risk attitudes: people will be risk averse (prefer the safe bet) for gains and risk seeking (prefer the risky option) for losses of moderate to high probability, and they will be risk seeking for gains and risk averse for losses of low probability.…”

Judgments relative to patterns: How temporal sequence patterns affect judgments and memory.

“…A long history of research analyzes how people reason about the processes underlying sequences and how they anticipate individual events in a sequence (see reviews in Ayton & Fischer, 2004;Kusev, van Schaik, Ayton, Dent & Chater, 2009;Oskarsson, van Boven, McClelland & Hastie, 2009; Sedlmeier & Betsch, 2002). Extensive research has also investigated memory for -and judgment of -the frequency of events encountered in temporal sequence (cf.…”

Uncertainty and its perception: experimental study of the numeric expression of uncertainty in two decisional contexts

“…The CPT uses a value function with the same characteristics appearing in PT: the innovation lies in the application of probability weighting functions (Kusev et al 2009). Kahneman and Tversky made many experiments to test the weights.…”