The Psychology of Risk

Risk is commonly defined in negative terms-the probability of suffering a loss or factors and actions involving uncertain dangers or hazards. On the other hand, the term risk as used in the social sciences relies on simply the degree of uncertainty: It merely addresses how much variance exists among the possible outcomes associated with a particular choice or action. A counterintuitive example is the classifying of an investment that is certain to lose $5 as less risky than one that has an equal chance of yielding a gain of $10. Andreassen states that uncertainty and value are treated as separate entities because expanding the notion of risk to include gains as well as losses adds considerable conceptual power.

Economic theories based on perfect rationality are undoubtedly powerful. Andreassen states that id one wanted to predict human behavior in the simplest manner, one would certainly begin by assuming that people are motivated by self-interest, and that they can be extremely calculating when valuable opportunities arise, learning quickly from the success of others. Research on the psychology of risk does not begin by assuming that all human behavior is irrational, random, or thoughtless. Rather, this research has centered on how people may be biased by myriad social influences, the perceived choices available, or the cognitive rules of thumb used to simplify difficult economic and social decisions.

Working Paper No. 87(1.08 MB)