Financial prospect relativity: context effects in financial decision‐making under risk

Abstract

We report three studies in which methodologies from psychophysics are adapted to investigate context effects on individual financial decision-making under risk. The aim was to determine how the range and the rank of the options offered as saving amounts and levels of investment risk influence people's decisions about these variables. In the range manipulation, participants were presented with either a full range of choice options or a limited subset, while in the rank manipulation they were presented with a skewed set of feasible options. The results showed that choices are affected by the position of each option in the range and the rank of presented options, which suggests that judgments and choices are relative.

Robust, domain‐specific effects of prior context in risk preferences for pension choice

“…Such a result is consistent with sensitivity to absolute value. This result is in line with the findings of Vlaev et al (, ), but contrary to Stewart et al () where in seven out of eight studies, sensitivity to absolute values was not observed.…”

“…Why did Stewart et al () find no sensitivity to absolute value, whilst we and Vlaev et al (, ) did? This difference might relate to the latters' use of a real‐world context involving the investment of large sums of money.…”

“…Vlaev et al's () results are consistent with theories of relative judgement, including Adaptation Level Theory (ALT; Helson, ), Range Frequency Theory (RFT; Parducci, , ), and Decision by Sampling (DbS; Stewart, Chater, & Brown, ). Whilst ALT suggests that judgments are made relative to the mean of recently experienced prospects, DbS and RFT both hold the rank of a prospect within a particular set to be fundamental in judgement.…”

“…DbS maintains that subjective evaluations of an attribute derive from that attribute's rank position in a comparison sample drawn from memory. Evidence for DbS has been obtained from two main sources: (a) demonstrations that the distribution of “attributes” in the world is such that, were people sampling from a long‐term memory distribution that reflected the real‐world distribution, rank‐positions would predict typical judgement and choice phenomena (Stewart et al, ; see also Olivola & Sagara, ; for a concise review, see Olivola & Chater, ); (b) effects of different distributions of attributes most likely to be sampled from memory (i.e., those recently experienced, or provided in the immediate choice context, e.g., Olivola & Sagara, ; Stewart & Reimers, 2008, as cited in Stewart, ; Stewart et al, ; Ungemach, Stewart, & Reimers, ; Vlaev et al, ).…”

Does the brain calculate value?

“…Prospect relativity is also observed in risky financial decisions when choices of saving rates and investment risk are affected by the position of each option in the rank of presented options [66]. Relativity effects are also seen in judgments of income.…”