Risk aversion (psychology)

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.[1] To explain risk aversion within this framework, Bernoulli proposed that subjective value, or utility, is a concave function of money.[1] Consequently, the concavity of the utility function entails a risk averse preference for a sure gain of $800 over an 80% chance to win $1,000, although the two prospects have the same monetary expected value.[5] Modern Portfolio Theory (MPT) was created by economist Harry Markowitz in 1952 to mathematically measure an individual's risk tolerance and reward expectations.In contrast to EUT, PT is posited as an alternative theory of choice, in which value is assigned to gains and losses rather than to final assets (total wealth), and in which probabilities are replaced by decision weights.[1] Steepness of the utility function in the negative direction (for losses over gains) explains why people are risk-averse even for gambles with positive expected values.[1]The formulation of Problem 1 implicitly adopts as a reference point a state of affairs in which the disease is allowed to take its toll of 600 lives.The outcomes of the programs include the reference state and two possible gains, measured by the number of lives saved.[1] If preferences reverse based on inconsequential aspects of how the problem is framed, people cannot possibly be maximizing expected utility.[5] Latent here is the unsettling idea that people's preferences come from the outside (from whoever has the power to shape the environment and determine how questions are phrased), rather than from their own psychological makeup.[3] On the contrary, several between-participant studies have found that people are willing to pay less, on average, for a binary lottery than for its worse outcome, a finding coined the uncertainty effect (UE).As you hesitate, your friendly insurance agent comes forth with an alternative offer: "For half the regular premium you can be fully covered if the quake occurs on an odd day of the month.[8] Second, probabilistic insurance represents many forms of protective action, such as having a medical checkup, buying new tires, or installing a burglar alarm system.[2] In 2001, two researchers from the University of Chicago, Rottenstreich and Hsee, conducted a series of three experiments to illustrate probability-outcome dependence, using an affective approach.Both examples indicate probability-outcome dependence, as based on affect-rich outcomes, which changes the shape of PT's S-shaped curve.The following study demonstrates that the opposite pattern is also true: when the available outcome is negative, departures from impossibility engender fear, and deviations from certainty produce hope.Experiment 3 studied negative outcomes and also found evidence of a weighting function that is more S-shaped for affect-rich than affect-poor prizes.In comparison with their positive counterparts, negative stimuli receive a larger allocation of attention and a swifter response once recognized by the brain.[16][17] 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.[20][21] 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 order to complete this task successfully, participants must discern that the decks associated with net winning, yet low payoffs, maximize their utility.Damasio noticed that participants with damage to their orbitofrontal cortex were unable to realize that the deck associated with low payoffs yielded higher reward.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.While avoiding negative stimuli, perceived or real, is a simple enough action, it requires anticipation, motivation and reasoning.Similarly, fear-conditioning is the acquisition of knowledge that informs an individual that a particular neutral stimulus now predicts an event that endangers their psychological or physical well-being.The field of neuroeconomics is emerging as a unified branch of knowledge, intending to merge information from psychology, economics and neuroscience with hopes of better understanding human behaviour.Parsing out emotion and fear of loss from decision making would result in more implementation of mathematical calculations, thus maximizing expected utility.While activation in specific brain areas can highlight the mechanisms of decision making, evidence continues to support the prevalence of risk-averse behaviour.