Exaggerated Risk: Prospect Theory and Probability Weighting in Risky Choice

In five experiments we studied precautionary decisions where participants decided whether or not to buy insurance with specified cost against an undesirable event with specified probability and cost. We compared the risks taken for precautionary decisions with those taken for equivalent monetary gambles. Fitting these data to Tversky and Kahneman’s (1992) prospect theory we find that the weighting function required to model precautionary decisions differs from that required for monetary gambles. This result indicates a failure of the descriptive invariance axiom of expected utility theory. For precautionary decisions people overweighted small, medium-sized and moderately large probabilities - they exaggerated risks. This effect is not anticipated by prospect theory or experience-based decision research (Hertwig, Weber, Erev & Barron, 2004). We find evidence that exaggerated risk is caused by the accessibility of events in memory: the weighting function varies as a function of the accessibility of events. This suggests that people’s experiences of events “leak” into decisions even when risk information is explicitly provided. Our findings highlight a need to investigate how variation in decision content produces variation in preferences for risk