Irrational Economist_ Making Decisions in a Dangerous World - Erwann Michel-Kerjan [58]
CONCLUSION
Results from the behavioral experiments my colleagues and I have performed suggest that people become less threatened by ambiguity when it concerns events that are to take place far in the future, perhaps because we make most of our decisions for the short term, and because a long horizon is much less salient to many. This finding has important policy implications in many domains, including investment decisions, attempts to reduce global warming, mitigation strategies against natural disasters, and health risks that are not well identified. If individuals are less ambiguity-averse for such future prospects, we would expect to see underinvestment in reducing or managing these risks today.
How can we properly handle future uncertainty? Designing policies and regulations that properly deal with our myopia (i.e., our strong focus on what can happen tomorrow rather than what can happen in ten years) would potentially help us make better choices about our future. Here’s a good example from the financial markets: As a way of encouraging bankers to consider the long-term implications of their actions, the executive compensation system could be redesigned so that it promotes a risk-adjusted reward mechanism where bonuses are a function not only of short-term market performance but also of sound risk profiles. This would align the interests of executives with the general public in managing financial risks more efficiently.
The foregoing suggests that in order to be in better shape to endure difficult times—whether in the form of financial crises, natural disasters, or any other large-scale risks—we need to rethink our way of dealing with ambiguity and to understand the future consequences of our immediate actions. Ignoring the sources of ambiguity or postponing actions against them will only result in bigger problems in the future. The natural disasters of the last decade, the economic crisis of 2008, and the data on global warming all serve as an important wake-up call for implementing sound risk management policies that can reduce our myopia in managing long-term uncertainties.
RECOMMENDED READING
Ellsberg, D. (1961). “Risk, Ambiguity and the Savage Axioms.” Quarterly Journal of Economics 75: 643-669.
Hogarth, R. M., and H. Kunreuther (1995). “Decision Making Under Ignorance: Arguing with Yourself.” Journal of Risk and Uncertainty 10: 15-36.
Kahneman D., P. Slovic, and A. Tversky (1982). Judgment Under Uncertainty: Heuristics and Biases. New York: Cambridge University Press.
Liberman, N., and Y. Trope (1998). “The Role of Feasibility and Desirability Considerations in Near and Distant Future Decisions: A Test of Temporal Construal Theory.” Journal of Personality and Social Psychology 75: 5-18.
Onay, S., and A. Onculer (2007). “Intertemporal Choice Under Timing Risk: An Experimental Approach.” Journal of Risk and Uncertainty 5, no. 34: 2.
14
Dreadful Possibilities, Neglected Probabilities
CASS R. SUNSTEIN AND RICHARD ZECKHAUSER
Dreadful possibilities stimulate strong emotional responses, such as fear and anxiety.1 Fortunately, most high-consequence negative events have tiny probabilities, because life is no longer nasty, brutish, and short. But when emotions take charge, probabilities get neglected. Consequently, in the face of a fearsome risk, people often exaggerate the benefits of preventive, risk-reducing, or ameliorative measures. In both personal life and politics, the result is harmful overreactions to risks.
One salient manifestation of probability neglect is that in two situations involving the same dreadful possibility, one much more likely to unfold than the other, individuals may value risk elimination nearly equally even though probabilities may differ by a factor of 20 or more. People focus on the bad outcome itself, and are inattentive to how unlikely it is to occur—hence their overreaction when the risk is