Determinants of Risk Taking:The Important Role of Risk Perception
Elke U. Weber
Columbia Business School
and Center for the Decision Sciences
SAMSI Presentation, October 4, 2007
Talk Preview
Economic Theory and Risk Taking
Risk Taking: Attitude and Perception
Cultural and Personality Differences
How we Deal with Rare Events
Conclusions
What does economic theory/finance tell us about the determinants of risk taking?
Traditional economics/finance models Expected Utility (EU) theory Risk-return models, like CAPM
Risk is an (invariant) attribute of the risky (investment) option
Risk Attitude/Risk Tolerance is the only thing presumed to vary between individuals
Risk Attitude/Risk Tolerance as a Personality Trait
While technically only a parameter of a utility function, risk attitudes are often given interpretations as personality traits
Psychometric scales measure degree of risk-aversion/risk-seeking (Kogan & Wallach, 1962)
Risk-attitude used as a selection criterion in some hiring decisions or client/advisor matchings
Problem with Risk Attitude as a Personality Trait
Risk taking of any given individual varies across contexts and situations
Anecdotal evidence manager who is risk neutral with company money, but
risk averse in her personal financial decisions rock climber who takes plenty of recreational risks but is
anxious about missing flights Systematic comparison of risk taking financial,
health, recreational, ethical or social decisions (Weber, Blais, Betz, 2002)
DoSpeRT Items (Weber, Blais, Betz, 2002)
Admitting that your tastes are different from those of a friend. (S)
Going camping in the wilderness. (R)
Betting a day’s income at the horse races. (I)
Swimming far out from shore on an unguarded lake or ocean. (R)
Investing 10% of your annual income in a moderate growth mutual fund. (I)
Not wearing a seat belt when being a passenger in the front seat. (H)
Taking some questionable deductions on your income tax return. (E)
Disagreeing with an authority figure on a major issue. (S)
F H E R S Total
F 1.00 .60
H .29 1.00 .60
E .51 .61 1.00 .45
R .36 .34 .34 1.00 .75
S -.07 .06 .04 .13 1.00 .33
DoSpeRT Subscale correlations (Weber, Blais, Betz, 2002)
Study 3
Hanoch, Johnson, & Wilke, Psych Science, 2006
Recreation targetsbungee jumpershang glidersscuba divers
Gambling targetscasino gamblers
Investment targetsstock-trading clubs
Health targetssmokers
gym members
Problem with single determinant (parameter) for risk preference
Need to account for both situational and chronic/biological differences in risk taking
Age and gender differences in sensation seeking
Hard to do so with a single parameter Is risk attitude really the only determinant of risk taking that
varies between individuals or situations?
Behavioral models of risk taking add determinants Prospect Theory
Adds loss aversion and probability weighting Generalize risk-return models (Weber & Milliman, Mgt Sci,
1997) Perceived riskiness of risky choice options seen as a psychological
variable
Risk Perception as Mediator of Situational Differences
Perception is subjective and varies with Expected outcome volatility Goals, expectations, and other reference points Familiarity with risky option and perceived
control Home bias effects in investing mediated by differences in
perceived riskiness (Kilka & M. Weber, 2000; Weber et al., 2005) Other affective responses (dread and fear)
Risk as a feeling (Loewenstein, Weber, Hsee, & Welch, 2001) Personal experience of adverse consequences
Risk Perception as Mediator of Situational Differences
Perception is relative Thurber story Two thought experiments
buckets of water two inheritances
Also true of perceptions of difference/volatility Weber’s law from 19th century psychophysics
difference in magnitude required to perceive two stimuli as different (JND) is proportional to absolute stimulus magnitude
Coefficient of variation (CV) as a measure of perceived volatility CV = standard deviation / expected value
measure of relative risk: risk per unit of return Used in many applied areas
engineering, medicine, agricultural economics
Relative-risk coefficient of variation predicts risky foraging behavior of animals across a range of situations(S. Shafir, 2000)
Risk taking
Distinguish between Perception
Evaluation of outcomes and probabilities (hot or cold) Motivation
Whether risk as perceived is exciting or scary Probably related to optimum arousal set points
Sensation seeking (Zuckerman)
Perceived-risk attitude (PRA), b:
Willingness to take(X) = a(Benefit(X)) + b(Perceived Risk(X)) + c
Perceived Risk Attitude (Weber, Blais, Betz, 2002)
Domain averse neutral seeking
F 44 72 0
H 45 70 1
R 43 71 0
E 49 65 2
S 50 66 0
Some effects attributed to “risk attitude” due to non-attitudinal factors Perceptions of risk (and of return) Probability weighting Loss aversion
Cultural Differences in Risk Taking Mediated by Differences in Perceived Riskiness
Study of investment decisions made by Chicago and Shanghai business students, where Chinese appeared less risk averse than Americans Chinese had greater WTP for same investment options
“Cushion” hypothesis Cultural collectivism provides implicit insurance against catastrophic
losses, so risks are objectively reduced Investors with larger “collectivist” networks (mostly Chinese)
perceived risks of investment options to be lower Risk perceptions and risk taking only different between cultures for
outcome dimensions that are transferable For money, but not for health or grades
No cultural differences in attitude towards perceived risk, b WTP(X) = EV(X) – bR(X), where R(X) is stated subjective
perceived risk of investment option X, not Var(X)
Not all differences in perceived riskiness are “rational”/justifiable
Gender differences in risk taking Women’s pension investments are more
conservative than those of men Women take fewer risks than men in all
domains, except for social risks But also perceive the risks to be greater in those
domains than men do (Weber, Blais, Betz, 2002) No gender differences in perceived risk attitude
Gender differences in perceived risk
Probably not biological, since restricted to cultural majorities White males perceive risks to be lower than any other
group (Flynn et al., 1994) Sociological/psychological explanation for group
differences in perceived risk Majority members do not “take risks,” they have the power to
“manage risks” Perceived controllability one of the psychological risk
dimensions identified by Slovic et al. in 1960s and 70s Driving seen as safer than flying
Emotional mediation of effect Responsible for false generalization to domains where no
gender differences in controllability exist (investment decisions)
Risk taking in decisions from description vs. decisions from experience
Decisions from Description outcome distribution fully described
numerically or graphically almost exclusively studied in human choice
Weber, Shafir, Blais (2004)
Decisions from Experience outcome distribution initially unknown
knowledge of outcome distribution acquired by personal exposure in repeated choices
strong recency in effect of prior observations exclusively studied in animal choice
recent resurgence of interest in reinforcement learning models Camerer & Ho (1999), March (1996)
Effect of rare events
Rare events are Overweighted in decisions from description
Captured by decision weight function of Prospect Theory Underweighted in decisions from experience
Unless they recently occurred, in which case they are strongly overweighted (Hertwig et al., 2004)
Risk taking under the two information conditions can be very different as a result, when outcome distributions are skewed
Most investment decisions based on a combination of outcome distribution description and personal experience Personal experience typically the stronger determinant of choice
More emotionally engaging, vivid
Decomposing risk taking into risk perception and risk attitude: What does it buy us? Improved understanding of individual or group
differences in risk taking Not all differences in risk taking are due to differences in
attitude towards risk (liking it or disliking it), though some are
Probably related to biological differences in optimal arousal set points
Differences in perceived risk can be due to Stable differences in sociocultural environment Transient situational characteristics
Differences in perceived risk can be Justifiable and realistic responses to differences in opportunities or
constraints Less justifiable myopic emotional reactions to events or emotional
overgeneralizations
Summary
Talk tried to introduce you to a different perspective on risk taking (in financial and other contexts) “Psychology” component of risk taking is not
restricted to individual or group differences in risk attitude
Richer framework that unconfounds differences in risk perception from differences in true attitude towards risk resolves many apparent paradoxes
Inconsistent risk attitudes across domains Rabin’s (2000) calibration theorem
Possible Take Away
Better appreciation of the influence of non-analytic processes on risky decisions
Better appreciation of the malleability of perceptions of risk Risk is not an immutable attribute of a risky choice
option Mode by which information about outcome
variability is acquired, familiarity and emotional comfort, and expectations and other relative comparisons can play important roles
Top Related