The role of intuition and reasoning in driving aversion to risk and ambiguity

Abstract

Using information on a large sample of retail investors and experimental data we find that risk aversion and risk ambiguity are correlated: individuals who dislike risk also dislike ambiguity. We show that what links these traits is the way people handle decisions. Intuitive thinkers are less averse to risk and less averse to ambiguity than individuals who base their decisions on effortful reasoning. We confirm this finding in a series of experiments. One interpretation of our results is that the high-speed of intuitive thinking puts intuitive thinkers at a comparative advantage in situations involving high risk and ambiguity, making them less averse to both. Consistent with this view we show evidence from the field and from the lab that intuitive thinkers perform better than deliberative thinkers when making decisions in highly ambiguous and risky environments. We also find that attitudes toward risk and ambiguity are related to different individual characteristics and wealth. While the wealthy are less averse to risk, they dislike ambiguity more, a finding that has implications for financial puzzles. JEL classification: D81; D83.

Measuring Ambiguity Preferences

“…Yet, their three-category classification is based on a small sub-sample of their data, consisting of only 38 students. 10 The non-incentivized version of the Ellsberg urn experiment with five answer possibilities shows a somewhat smaller fraction of ambiguity neutral subjects compared to Butler et al (2013). The results for the subjects' willingness to pay for complementary temperature lottery tickets are qualitatively similar to Fox and Tversky (1995), although their average relative ambiguity premium is with 39% around twice as large as in our experiment that exhibits an average relative ambiguity premium of 20%.…”

“…The two tasks to elicit ambiguity preferences are based on the works by Lauriola and Levin (2001), Chakravarty and Roy (2009) and Butler et al (2013). Since ambiguity preferences are closely related to risk preferences (Chakravarty and Roy, 2009), we also include an task to elicit risk preferences, similarly taken from Chakravarty and Roy (2009).…”

“…First, we replicate the seminal two-color Ellsberg (1961) urn experiment. Similar to Butler et al (2013), subjects are offered five different answer possibilities to allow differentiating between different degrees of ambiguity preferences. The second thought experiment places the Ellsberg (1961) experiment in a more realistic setting of horse betting.…”

Creativity: Intuitive processing outperforms deliberative processing in creative idea selection

“…The existing literature has identified a positive relation between deliberative decision-making tendency and risk aversion. It has been shown that deliberative thinkers are more risk-aversive than intuitive thinkers, and that in risky and uncertain decision making environments deliberative processing is more likely to lead to conservative and risk-aversive decisions (Butler, Guiso, & Jappelli, 2014). Therefore, during creative idea selection, deliberative thinkers may focus on evaluating the potential risks of the available ideas.…”

Are the poor worse at dealing with ambiguity?

“…And ambiguity aversion has predictive power for real life decisions (Ross et al 2012;Engle-Warnick et al 2011;Sutter et al 2013;Bianchi and Tallon 2014;Dimmock et al 2016a, b). However, the literature on the relationship between risk aversion and income 1 is much richer than the literature on the relationship between ambiguity aversion and income (Akay et al 2012;Butler et al 2014;Dimmock et al 2016b). The main reason for this gap in the literature is that until recently no tools were available to measure ambiguity attitudes in natural circumstances.…”