Extreme Outcomes Sway Risky Decisions from Experience

Abstract

Whether buying stocks or playing the slots, people making real-world risky decisions often rely on their experiences with the risks and rewards. These decisions, however, do not occur in isolation but are embedded in a rich context of other decisions, outcomes, and experiences. In this paper, we systematically evaluate how the local context of other rewarding outcomes alters risk preferences. Through a series of four experiments on decisions from experience, we provide evidence for an extreme-outcome rule, whereby people overweight the most extreme outcomes (highest and lowest) in a given context. As a result, people should be more risk seeking for gains than losses, even with equally likely outcomes. Across the experiments, the decision context was varied so that the same outcomes served as the high extreme, low extreme, or neither. As predicted, people were more risk seeking for relative gains, but only when the risky option potentially led to the high-extreme outcome. Similarly, people were more risk averse for relative losses, but only when the risky option potentially led to the low-extreme outcome. We conclude that in risky decisions from experience, the biggest wins and the biggest losses seem to matter more than they should.

The Role of Memory in Distinguishing Risky Decisions from Experience and Description

“…The extra block of decisions from experience was included because past research indicated that decisions from description remain relatively stable across blocks, whereas preferences develop over training for decisions from experience as the outcomes associated with each option are learned (Ludvig & Spetch, 2011;Ludvig et al, 2014a).…”

“…Each door/option appeared equally often on either side of the screen. Performance of lower than 60% on catch trials in either decisions from description or experience across the whole experiment was used as an exclusion criterion, following established protocol from previous experiments (Ludvig et al, 2014a(Ludvig et al, , 2014bLudvig & Spetch, 2011;Madan et al, 2014Madan et al, , 2015. Data from 18 of the 256 participants were thus excluded.…”

“…In previous work with such a partialfeedback design, we showed that when these experienced risky options potentially lead to an extreme, but common, outcome (i.e., the highest and lowest outcomes in a context), people are more risk seeking for gains than for losses-the opposite of the usual reflection effect in description (e.g., Ludvig et al, 2014a). Moreover, the degree of risk preference in both the gain and loss domains for these decisions from experience correlates with inter-individual differences in the memory for the extreme outcomes (Madan et al, 2014).…”

Magnitude and incentives: revisiting the overweighting of extreme events in risky decisions from experience

“…One key characteristic of demonstrating the reversedreflection effect in experience-based choice is the intermixing of gain and loss decision trials within the same experimental task: participants on each trial are presented with a choice pair (certain and risky options) framed as either gains or losses (the Method section and for more details see, Ludvig et al, 2014). This intermixing of gain and loss trials appears to be crucial because when participants are presented with decision trials in a block-wise manner (repeated play from the gain trials followed by the loss trials or vice-versa), then the standard reflection effect is observed (see Erev, Ert, & Yechiam, 2008;Ert & Yechiam, 2010;Ludvig et al, 2014).…”

“…This intermixing of gain and loss trials appears to be crucial because when participants are presented with decision trials in a block-wise manner (repeated play from the gain trials followed by the loss trials or vice-versa), then the standard reflection effect is observed (see Erev, Ert, & Yechiam, 2008;Ert & Yechiam, 2010;Ludvig et al, 2014).…”