"it is extremely hard (for people) to think about ...uncertainty, probability, and risk." Indeed, repeated demonstrations have shown that most people lack an adequate understanding of probability and risk concepts A number of principles or concepts have been uncovered which describe how people think about probability and risk. A few of these concepts will be described here.
Misperception of Small Probabilities. It is obvious that people can only respond to the risks they perceive. One persistently reported misperception is an inability to react logically with low probability events (Anderson, 1974). People either ignore low probabilities or are unable to make rational decisions involving low probabilitie.
This misperception arises from a limited capacity people have for processing risk information. Simon's (1957) concept of "bounded rationality" contends that cognitive limitations force people to construct simplified models of the world. According to Simon (1957, p. 198), the decision maker "behaves rationally with respect to this model, (but) such behavior is not even approximately optimal with respect to the real world." Thus, people's limited processing capacity restricts attention for rare events.
Focus on Probability of Loss. People don't like to lose money (or anything else). This aversion to losing, however, seems focused more on the probability than the amount of loss: people choose a sure gain over a gamble, but reverse their preference when the same options are presented as losses. In short, people are apparently "captured" by the loss probability.
Risk Averse vs Risk Seeking : People are often risk seeking when it comes to losses; they are willing to chance a loss even when they can insure against it.... This tendency reflects the distaste people have for sure losses.
Gambler's Fallacy. Many people have a strong but false belief that random events are self-correcting. The inability to appreciate the independence of random events also shows up in low probability situations (Hogarth, 1987). If an unlikely event occurs once, people believe that it is less likely to occur again. That is, "lightning can't strike twice." Apparently, t he perceived likelihood of future events are changed as a result of prior outcomes.
Risk Homeostasis. A general principle of behavior is that people desire to remain at equilibrium level an optimal level of risk that people are comfortable in accepting Efforts to decrease risk, therefore, may be met by riskier behavior.
One example relates to farm machinery. When improved design made tractors more stable, farmers used them on steeper slopes and the accident rate remained constant. This suggests that risk-reduction measures may be offset by riskier subsequent behavior
Resistance to Change. Perceptions of risk are quite stable and resistant to change. Reliance on "personal experience may promote a false sense of security.... People's beliefs often change slowly and show extraordinary persistence in the face of contrary evidence people have a tendency to deceive themselves about how well they can handle risk. Through hindsight, for instance, we can "post-dict" almost any outcome -- after the fact
Overconfidence. Humans often operate under what has been labeled a "certainty illusion" -- a belief in their own infallibility ("Even when people are wrong, ... they are tremendously confident in their opinions.... People generally tend to underestimate their own vulnerability to certain sorts of risks"
Context Effects. Psychologists have long been aware of the prevalence of context effects in judgments. One class of such effects has been labeled "framing" by Kahneman and Tversky (1984). They found that people respond more positively to losses labeled as "cost of protection" than as "uncompensated losses
Misperception of Small Probabilities. It is obvious that people can only respond to the risks they perceive. One persistently reported misperception is an inability to react logically with low probability events (Anderson, 1974). People either ignore low probabilities or are unable to make rational decisions involving low probabilitie.
This misperception arises from a limited capacity people have for processing risk information. Simon's (1957) concept of "bounded rationality" contends that cognitive limitations force people to construct simplified models of the world. According to Simon (1957, p. 198), the decision maker "behaves rationally with respect to this model, (but) such behavior is not even approximately optimal with respect to the real world." Thus, people's limited processing capacity restricts attention for rare events.
Focus on Probability of Loss. People don't like to lose money (or anything else). This aversion to losing, however, seems focused more on the probability than the amount of loss: people choose a sure gain over a gamble, but reverse their preference when the same options are presented as losses. In short, people are apparently "captured" by the loss probability.
Risk Averse vs Risk Seeking : People are often risk seeking when it comes to losses; they are willing to chance a loss even when they can insure against it.... This tendency reflects the distaste people have for sure losses.
Gambler's Fallacy. Many people have a strong but false belief that random events are self-correcting. The inability to appreciate the independence of random events also shows up in low probability situations (Hogarth, 1987). If an unlikely event occurs once, people believe that it is less likely to occur again. That is, "lightning can't strike twice." Apparently, t he perceived likelihood of future events are changed as a result of prior outcomes.
Risk Homeostasis. A general principle of behavior is that people desire to remain at equilibrium level an optimal level of risk that people are comfortable in accepting Efforts to decrease risk, therefore, may be met by riskier behavior.
One example relates to farm machinery. When improved design made tractors more stable, farmers used them on steeper slopes and the accident rate remained constant. This suggests that risk-reduction measures may be offset by riskier subsequent behavior
Resistance to Change. Perceptions of risk are quite stable and resistant to change. Reliance on "personal experience may promote a false sense of security.... People's beliefs often change slowly and show extraordinary persistence in the face of contrary evidence people have a tendency to deceive themselves about how well they can handle risk. Through hindsight, for instance, we can "post-dict" almost any outcome -- after the fact
Overconfidence. Humans often operate under what has been labeled a "certainty illusion" -- a belief in their own infallibility ("Even when people are wrong, ... they are tremendously confident in their opinions.... People generally tend to underestimate their own vulnerability to certain sorts of risks"
Context Effects. Psychologists have long been aware of the prevalence of context effects in judgments. One class of such effects has been labeled "framing" by Kahneman and Tversky (1984). They found that people respond more positively to losses labeled as "cost of protection" than as "uncompensated losses
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