Risk is a ubiquitous feature of social and economic life. Almost every decision involves uncertain consequences. Emotions may provide guidance in this situation, but they can also be detrimental, particularly when immediate emotions make us misjudge risks. Emotions may not only lead to suboptimal individual choices, but may also have adverse macroeconomic effects, when affective reactions are correlated across individuals. Plane crashes, natural catastrophes, and terrorist attacks often have long-lasting and strong emotional consequences which may induce people to grossly overestimate the probability of such an event occurring again.
Nervous consumers and investors might reduce or stop spending, thereby triggering an economic recession.
Despite the plausibility of this argument little is known about the impact of affect on economic decision making. Therefore, the objective of this proposal is to examine the causal relationship between immediate emotions and risk taking behavior. Experimental studies in the framework of prospect theory (Kahneman and Tversky 1979) have demonstrated that risk preferences are largely reflected by a nonlinear probability weighting function. This function captures the phenomenon that people typically overestimate small probabilities and underestimate large probabilities.
Our study, therefore, focuses not only on risk taking behavior in general, but also on the specific shape of the probability weighting function.
We plan to conduct a series of laboratory experiments with real monetary incentives to test the following hypotheses:
1. Immediate emotions, present at the moment of decision making and often
unrelated to the decision at hand, impact risk taking behavior and the responsiveness to probability information.
2. When solving a decision problem, both deliberative and affective
processes are at work. If the deliberative system is preoccupied with some other demanding cognitive task, the affective system might gain control.
Assuming that the affective system cares more about outcomes than probabilities, we conjecture that people under cognitive load are less responsive to probability information.
3. Uncertain outcomes usually materialize at some later point in time.
Therefore, people’s time preferences will also play a role in risky decision making. We surmise that there is a systematic relationship between risk taking behavior and time preference: Patient people more sensitive to changes in probabilities than impatient people.
4. Empirical evidence suggests that in many circumstances women are more
risk averse than men. This finding may be due to women’s different affective reactions to risky situations. We will test whether women react differently to induced emotions and cognitive load than do men, and whether they are more patient as other studies indicate.