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Risk Preference

 

Explanations > Theories > Risk Preference

Description | Research | Example | So What? | See also | References 

 

Description

People will tend to be risk-seeking when it comes to losses. Thus they would rather risk a big loss in preference to suffering a certain moderate loss. This is how gamblers get hooked. Once they have made a loss, they keep gambling (sometimes in ever larger stakes) in trying to avoid the loss.

On the other hand, people tend to be risk-avoiding when it comes to gains, preferring to hold onto the bird in the hand. This is the mentality of the miser. Once they have something they are loathe to risk losing it.

There are three common perceived dimensions of risk. ‘risk dread’ which is about lack of control and potential serious harm, ‘unknown risks’ which are perceived but which we have little information on probability or impact (such as from new drugs). The third dimension is about how many people are exposed to risk.

Research

Tversky and Kahneman (1981) gave people the following choice:

 

A: A sure gain of $240

B: A 25% chance of gaining $1000 and a 75% chance of gaining nothing.

 

84% of people chose A, as a certain gain was preferred over a possible loss. They then offered the following:

 

C: A sure loss of $750

D: A 75% chance of losing $1000 and a 25% chance of losing nothing.

 

Now 87% chose D, preferring to avoid the certain loss, even though C (as B in the first test) has the better probable returns.

Example

We tend to accept greater levels of risk if we are in control, such as smoking and skiing as compared with external risks such as passive smoking and rail accidents.

So what?

Using it

To get someone to do something risky, frame the alternative as a certain loss. This can include non-financial loss such as a loss of social standing.

If they already have something and are asking for more, offer something higher value but risky, and in exchange for what they already have.

Defending

Recognize risks for what they are! Decide rationally, not by comparing with other losses. Keep accurate records. Beware of wishful thinking. Break compound decisions down into simple decisions.

See also

Framing, Plasticity, Psychological Accounting

References

Tversky and Kahneman (1981), Slovic (1987)

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