Risk aversion (psychology)
Risk aversion (psychology)
- Risk aversion** is a preference for a sure outcome over a gamble with higher or equal expected value. Conversely, rejection of a sure thing in favor of a gamble of lower or equal expected value is known as risk-seeking behavior.
The psychophysics of chance induce overweighting of sure things and of improbable events, relative to events of moderate probability. Underweighting of moderate and high probabilities relative to sure things contributes to risk aversion in the realm of gains by reducing the attractiveness of positive gambles. The same effect also contributes to risk seeking in losses by attenuating the aversiveness of negative gambles. Low probabilities, however, are overweighted, which reverses the pattern described above: low probabilities enhance the value of long-shots and amplify aversion to a small chance of a severe loss. Consequently, people are often risk seeking in dealing with improbable gains and risk averse in dealing with unlikely losses.
Related theories Most theoretical analyses of risky choices depict each option as a gamble that can yield various outcomes with different probabilities. Widely accepted risk-aversion theories, including Expected Utility Theory (EUT) and Prospect Theory (PT), arrive at risk aversion only indirectly, as a side effect of how outcomes are valued or how probabilities are judged. In these analyses, a value function indexes the attractiveness of varying outcomes, a weighting function quantifies the impact of probabilities, and value and weight are combined to establish a utility for each course of action. In most real-life situations, the probabilities associated with each outcome are not specified by the situation, but have to be subjectively estimated by the decision-maker. The subjective value of a gamble is again a weighted average, but now it is the subjective value of each outcome that is weighted by its probability. The theory was that constant variance allowed for a maximized expected return and to gain a constant expected return variance should be minimized. An asset must be considered in regard to how they will move within the market and by taking these movements into account an investment portfolio can be constructed that decreased risk and had a constant expected return. Standard deviation is a relative form of measurement and investors using this index for their risk assessment must analyse an appropriate context in which the market sits to ensure a quantified understanding of what the standard deviation means. In an effort to capture inconsistencies in our preferences, PT offers a non-linear, S-shaped probability-weighted value function, implying that the decision-maker transforms probabilities along a diminishing sensitivity curve, in which the impact of a given change in probability diminishes with its distance from impossibility and certainty.
In line with diminishing sensitivity, the first hundredth of probability is worth $10, and the last hundredth is worth $12, but the 98 intermediate hundredths are worth only $178, or about $1.80 per hundredth. PT captures this pattern of differentially weighting (objective) probabilities subjectively with an S-shaped weighting function. Framing effects play an integral role in risk-aversion, as an extension of PT's S-shaped value function, which illustrates the differences in how gains and losses are valued relative to a reference point.
Risky prospects are characterized by their possible outcomes and by the probabilities of these outcomes.
- For example, people are willing to pay an average of $26 for a $50 gift certificate, but only $16 for a lottery that pays either a $50 or $100 gift certificate, with equal probability.* showed that a hypothetical vaccine that reduces the probability of contracting a disease from 20% to 10% is less attractive if it is described as effective in half of the cases than if it is presented as fully effective against one of two exclusive and equally probable virus strains that produce identical symptoms.
Affective psychology of risk The earliest studies of risk perception also found that, whereas risk and benefit tend to be positively correlated in the world, they are negatively correlated in people's minds, and, therefore, judgments. The significance of this finding was not realized until a study by Alhakami and Slovic (1994) found that the inverse relation between perceived risk and perceived benefit of an activity (e.g., using pesticides) was linked to the strength of positive or negative affect associated with that activity as measured by rating the activity on bipolar scales such as good/bad, nice/awful, dread/not dread, and so forth. This result implies that people base their judgments of an activity or a technology not only on what they think about it but also on how they feel about it. This bias for negative information occurs very early on in the stages of processing, seen in the appearance of a P1, a component of the event-related potentials (ERP) gathered from an EEG (electroencephalography) output. Researchers localized this particular ERP to the ventrolateral occipital cortex. Given that a greater amount of attention is allotted to the processing of negative stimuli, the negativity bias may also be indicative of an attentional bias.
The negativity bias is noticeable in a plethora of situations related to the formation of risk-averse behaviour. Notably, any stimuli that evokes the expression of fear encourages risk -aversion. The human brain has adapted to easily parse out these stimuli from a sea of benign stimuli. In the laboratory, participants report and respond more quickly to negative stimuli; Photos of negative and threatening pictures jump out of an array of photos, capturing participants' attention more than positive or neutral pictures. Non-tangibles, such as personality traits, also demonstrate a similar impact for eliciting risk-averse behaviour. Carleston & Skowronski (1989) found that negative traits form a stronger impression on an individual than positive traits, thus affecting the overall impression of the individual being evaluated.
Emotion and decision making An individual's affect often determines the extent to which one's behaviour is effective in obtaining their goal. Decision making and emotion, intertwined, cannot be separated from each other, as emotion can either benefit or hinder the attainment of maximized utility.
Influence of emotion on decision making Three different emotional states influence decision making: Your current emotional state (i.e. How do you feel while you are making a decision?) Your past emotional state (i.e. How did you feel anticipating your decision?) Your future emotional state (i.e. How will your decision affect how you feel in the future; What effect will the decision have on your emotional well-being?)
Iowa gambling task Researching decision-making and affect, Antoine Bechara, Antonio Damasio and colleagues (2000; 2005) discovered that damage to a brain area associated with emotional processing impairs effective decision-making. After discovering that damage to the orbitofrontal cortex impaired participants from making goal-oriented decisions in social and professional contexts, Damasio and his colleagues designed the Iowa Gambling Task. In creating this task, Damasio wondered whether decision-making was afflicted because emotion was a necessary component to making effective decisions.
In the task, participants continuously draw from one out of four possible decks – participants may switch decks at any point during the study.
Each card possesses monetary value, resulting in either gains or losses.
Participants are unaware that 2 of the decks correspond to net winnings – low payoffs and even lower losses. The other 2 decks correspond to net losses – high payoffs and even higher losses.
Researchers instruct participants to maximize their utility – gain the most money by the end of the task. In order to complete this task successfully, participants must discern that the decks associated with net winning, yet low payoffs, maximize their utility.
- Results**. Damasio noticed that participants with damage to their orbitofrontal cortex were unable to realize that the deck associated with low payoffs yielded higher reward. From his discovery using the Iowa Gambling Task, Damasio formulated a Somatic marker hypothesis.
- Alternate Conclusions**. Other researchers suggest that the difficulty encountered by patients with orbitofrontal cortex damage on Iowa Gambling Task is because the task requires participants to change their initial perception of potential gains and losses. Participants are lured in by appealing rewards, then confronted with devastating losses. Thus, orbitofrontal cortex damage inhibits the adaptation to changing patterns of rewards and punishment. This conclusion has been replicated in primates, where orbitofrontal damage prevented the extinction of a learned association.
Somatic marker theory Damasio posited that emotional information in the form of physiological arousal, is needed to inform decision making. When confronted with a decision, we may react emotionally to the situation, a reaction that manifests as changes in physiological arousal in the body, or somatic markers. Given data collected from the Iowa Gambling Task, Damasio postulated that the orbitofrontal cortex assists individuals in forming an association between somatic markers and the situations that trigger them. Once an association is made, the orbitofrontal cortex and other brain areas evaluate an individual's previous experiences eliciting similar somatic markers. Once recognized, the orbitofrontal cortex can determine an adequate and swift behavioural response, and its likeliness for reward.
Neuroscience of risk aversion #### Regret and risk aversion Several brain areas are observed in the expression of risk-averse behaviour. The previously mentioned orbitofrontal cortex is amongst these brain areas, supporting the feeling of regret. Regret, an emotion which heavily influences decision making, leads individuals to make decisions which circumvent encountering this emotion in the future.
Studying brain activity associated with regret, researcher Georgio Coricelli and his colleagues (2005) triggered feelings of regret in healthy participants, by having them complete a gambling task in which they were informed that the best choice was the unchosen option. Using functional magnetic resonance imaging (fMRI), Coricelli found that increasing regret correlated with increased activity in the medial orbitofrontal cortex, the anterior cingulate cortex, and the anterior hippocampus.
The amygdala, previously mentioned as a region showing high activity for the emotion of regret, is the central recipient for brain activity concerning fear-conditioning. Several streams of information from multiple brain areas converge on the lateral amygdala, allowing for the creation of associations that regulate fear-conditioning; Cells in the superior dorsal lateral amygdala are able to rapidly pair the neutral stimulus with the aversive stimulus. Cells that project from the lateral amygdala to the central amygdala allow for the initiation of an emotional response if a stimulus is deemed threatening.
- Cognitive Control.* Evaluating a gamble and calculating its expected value requires a certain amount of cognitive control. Several brain areas are dedicated to monitoring the congruence between expected and actual outcomes. Evidence by Ridderinkhof et al. (2004) suggests that the posterior medial frontal cortex (pMFC) and the lateral prefrontal cortex (LPFC) are involved in goal-directed performance monitoring and behaviour modulation. The pMPC monitors response conflicts (any situation that activates more than one response tendency), decision uncertainty, and any deviation from the anticipated outcome. Activation in the pMPC increases significantly after an error, response conflict, or unfavorable outcome is detected. As a result, the pMFC can signal a need for performance adjustment; there is a lack of evidence, however, indicating that the pMFC controls modulatory behaviour. Behaviour control processes in the LPFC have been implicated in the modulatory behaviour observed by researchers.