Decision making under risk: prospect theory approach and cognitive reflection test

Abstract

Behavioral finance aims to understand the reasoning patterns of investors, constrained by emotional processes, and how they influence the decision-making. This motivated the work, whose purpose is to evaluate individuals' decision-making behavior under risk/uncertainty. The methodological procedure adopted exploratory research through a questionnaire grounded by the prospect theory and the cognitive reflection test with 329 responses from individuals in Portugal. The results are aligned with the Kahneman and Tversky's study. Moreover, they support different behaviors between non-investors and investors, and consistency between non-familiar and familiar with the behavioral finance. Although the ratio of correct answers to the cognitive reflection test is low, it is higher in the group of investors and the male gender. The combination of the results identified groups of high and low cognitive aptitude with different responses to the effects of the prospect theory. Overall, individuals' decision-making seems to be influenced by cognitive biases and the intuitive system. The findings are important because they highlight the importance of strategic financial literacy plans