14. Risk Aversion

Bykdilkina

A related concept to loss aversion is risk aversion.

What Is Risk Aversion?

Risk aversion is our preference for more concrete and certain outcomes over uncertain (or risky) outcomes. This phenomenon was first described and has been extensively studied in the context of economic decision-making (Kahneman & Tversky, 1979). However, it can also be relevant in daily contexts, including social situations.

Example: Making plans

Imagine you are on a trip with a group of friends. You’ve arrived at your destination and start making plans for the next day — you want to do something active outdoors. Do you go on a hike up the nearby mountain, or do you rent bikes and explore the town?

What would you choose, and why?
How can risk aversion affect your choice? How about other biases?[4]

There have been arguments that risk aversion has an evolutionary basis — making decisions that lead to more predictable and certain outcomes promotes survival (Zhang et al., 2014). That said, many factors play a significant role in and affect the degree to which an individual is risk averse, including:

As noted above, risk aversion is related to loss aversion. If the outcomes of a choice are unknown, even if they could be either positive or negative, we are prone to avoid this choice because we attribute more weight to the negative (i.e. the loss).

Example: Relationships

If you are single, risk aversion could keep you from starting a relationship — even if you are unhappy being alone.
If you are in a relationship, risk aversion could keep you from ending it and becoming single — even if you are unhappy in it. 

Can you explain why? Can you see other biases in play here? [5]

Behavioural and neuroscientific evidence suggests that the underlying mechanism of risk aversion may have to do with emotions, specifically apprehensiveness of the unknown and (the anticipation of) the experience of regret (e.g., Coricelli et al., 2005; Mellers et al., 1997).

[4] Risk aversion would lead most people to choose the second option. But if you have a lot of experience hiking (and less experience biking), the status quo bias may lead you to the first option.

[5] Risk aversion is about choosing options that offer certainty and avoiding options with lots of unknowns. In this case, if you are single, you know what that is like and what to expect. In contrast, starting a new relationship has a lot of uncertainty. Similarly, if you have a partner, you know what it is like to be with them. Meanwhile, what life will be like being alone (after this relationship) is to at least some degree unpredictable.

Another bias that can contribute to your decision here is the status quo bias — avoiding change and continuing to do what you are already doing.

Finally, loss aversion may also come into play. Assuming that there are both positive and negative aspects of your current situation, changing that would mean letting go of all of it. Because we perceive losses as bigger than gains, even though getting rid of the negative would be a gain, getting rid of the positive would be a loss that we may appraise as more important; therefore, we would avoid it.

Another bias that may be relevant here, which we have not discussed but may be helpful for you to be aware of, is the sunk cost fallacy. It is related to the status quo bias and loss aversion, but it is distinct. The sunk cost fallacy is when we maintain the status quo (i.e. continue to do what we are doing, for example remain in a potentially dysfunctional relationship) because we have already invested valuable time/effort/resources in it (this is the “sunk cost” that we feel would be for nothing if we change course now).

The “fallacy” comes from the fact that the investment is already done and will never be recovered. If the outcomes are unsatisfactory, objectively speaking, one should likely interpret that as a sign to stop investing further. At the least, one should recognize that having previously devoted resources to this endeavour should not affect the current decision of whether to continue to do so. However, most people do not realize that (in both automatic and systematic processing) the sunk cost fallacy affects their decisions.

Brooks, H. R., & Sokol-Hessner, P. (2020). Quantifying the immediate computational effects of preceding outcomes on subsequent risky choices. Scientific Reports, 10(9878). https://doi.org/10.1038/s41598-020-66502-y.

Coricelli, G., Critchley, H. D., Joffily, M., O’Doherty, J. P., Sirigu, A., & Dolan, R. J. (2005). Regret and its avoidance: A neuroimaging study of choice behavior. Nature Neuroscience, 8, 1255–1262. https://doi.org/10.1038/nn1514.

Eckel, C. C., & Grossman, P. J., (2008). Chapter 113 men, women, and risk aversion: Experimental evidence. Handbook of Experimental Economics Results, 1, 1061–1073. https://doi.org/10.1016/S1574-0722(07)00113-8.

Kahneman, D., & Tversky, A. (1979). Prospect theory: An analysis of decision under risk. Econometrica, 47(2), 263–292. https://doi.org/10.2307/1914185.

Mellers, B. A., Schwartz, A., Ho, K., & Ritov, I. (1997). Decision affect theory: Emotional reactions to outcomes of risky options. Psychological Science, 8(6), 423-429. https://doi.org/10.1111/j.1467-9280.1997.tb00455.x.

Wang, J., Cui, R., Stolarz-Fantino, S., Fantino, E., & Liu, X. (2022). Differences in mood, optimism, and risk-taking behavior between American and Chinese college students. Frontiers Psychology, 12(781609). https://doi.org/10.3389/fpsyg.2021.781609.

Yuen, K. S. L., & Lee, T. M. C. (2003). Could mood state affect risk-taking decisions? Journal of Affective Disorders, 75(1), 11–18. https://doi.org/10.1016/S0165-0327(02)00022-8.

Zhang, R., Brennan, T. J., & Lo, A. W. (2014). The origin of risk aversion. Proceedings of the National Academy of Sciences, 111(5), 17777–17782. https://doi.org/10.1073/pnas.1406755111.

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