Theoretical Perspectives on Risk-Taking Behaviours

Lecture 9

Normative Theories

rational

top-down approach

maximise utility

what people SHOULD do

Descriptive Theories

behavioural

bottom-up approach

heuristics, biases

what people ACTUALLY do

Normative - Expected Utility Theory (EUT)

Bernoulli - people make decisions by maximising expected utility, where utility = subjective value (satisfaction/happiness).

EUT - St. Petersburg Paradox

proves humans don’t make decisions based on pure maths.

fair coin flipped until heads 1st time. player wins $2n, where n=number of times coin flipped. 

paradox - rational choice suggests should pay any fee for single play at game, despite winning small amount. unappealing to act rationally in game.

Assumptions of EUT

best alternative - people can always make clear choice between 2 options

description invariance - two options logically identical, should treat them the same

independence/cancellation - two choices share identical parts - shouldn’t matter - choice should depend only on diff. parts.

invariance - choice should not change when same info presented in diff. way.

Criticisms of EUT

real people violate rationality axioms.

cannot explain ambiguity e.g. Ellsberg ambiguity aversion (tend to avoid investing in what we don’t understand/probability hard to estimate).

assumes stable preferences - rarely true.

utility function not well defined.

no account for emotions, context, cognitive biases.

Descriptive - Prospect Theory (PT)

Tversky & Kahneman (1981):

• people judge outcomes as gains/losses not outcomes

• losses feel stronger than equivalent gains (loss aversion)

• people simplify decisions with mental shortcuts

• people misjudge probabilities

two phases:

1. editing → people simplify problems - identify gains/losses, ignore irrelevant details

2. evaluation → people judge options using value function and probability weighting

Loss Aversion

emotional impact of loss twice as strong as equal gain (Kahneman & Tversky, 1979).

losses trigger stronger responses in valuation areas. leads to risk-seeking in loss (Tom, Fox & Trepel, 2007).

Certainty Effect

often choose smaller certain gain over larger gamble (risk-aversion in gains).

stronger brain activation for sure gains than risky gains (Trepel, Fox & Poldrack, 2005).

stronger amygdala activation when choosing between certain vs risky options, even when expected value equal (De Martino et al., 2010).

Framing

diff. descriptions of same thing change decisions. affects whether something feels like gain/loss.

pos. framing highlights gains. neg. framing highlights losses.

often choose diff. even when outcomes identical → linked to loss aversion e.g. Asian Disease Paradigm

Attribute Framing - Food Labels

describing a feature changes perception. highlight best, underplay negatives = consumers base decisions on single attribute.

Leven et al. (1998) - consumers rate ground beef ‘75% lean’ better/healthier than ‘25% fat’.

Scarcity/Urgency Frames

‘only 3 left in stock’ = quantity-based scarcity.

‘offer ends tonight’ = time-based scarcity.

‘members only’ = access-based scarcity.

Sound Framing

valence transfer of emotions from music → words → faces.

musical frame can intensify/dilute associated emotion e.g. rock music intensify expected impact of energy drink.

Pantoja & Borges (2021) - faster music enhances perceived food taste + buy intentions