Cognition and Wealth: The Importance of Probabilistic Thinking
AbstractThis paper utilizes a large set of subjective probability questions from the Health and Retirement Survey to construct an index measuring the precision of probabilistic beliefs (PPB) and relates this index to household choices about the riskiness of their portfolios and the rate of growth of their net worth. A theory of uncertainty aversion based on repeated sampling is proposed that resolves the Ellsberg Paradox within a conventional expected utility model. In this theory, uncertainty aversion is implied by risk aversion. This theory is then used to propose a link between an individual’s degree of uncertainty and his propensity to give “focal” answers of “0”, “50_50” or “100” or “exact” answers to survey questions and the validity of this interpretation is tested empirically. Finally, an index of the precision of probabilistic thinking is constructed by calculating the fraction of probability questions to which each HRS respondent gives a non-focal answer. This index is shown to have a statistically and economically significant positive effect on the fraction of risky assets in household portfolios and on the rate of growth of these assets longitudinally. These results suggest that there is systematic variation in the competence of individuals to manage investment accounts that should be considered in designing policies to create individual retirement accounts in the Social Security system.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by University of Michigan, Michigan Retirement Research Center in its series Working Papers with number wp007.
Length: 52 pages
Date of creation: Jun 2001
Date of revision:
Contact details of provider:
Postal: P.O. Box 1248, Ann Arbor, MI 48104
Phone: (734) 615-0422
Fax: (734) 647-4575
Web page: http://www.mrrc.isr.umich.edu/publications/papers/
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- R. Mehra & E. Prescott, 2010.
"The equity premium: a puzzle,"
Levine's Working Paper Archive
1401, David K. Levine.
- Lee A. Lillard & Robert J. Willis, 1976.
"Dynamic Aspects of Earnings Mobility,"
NBER Working Papers
0150, National Bureau of Economic Research, Inc.
- James M. Poterba & David A. Wise, 1999.
"Individual Financial Decisions in Retirement Saving Plans and The Provision of Resources for Retirement,"
NBER Working Papers
5762, National Bureau of Economic Research, Inc.
- James M. Poterba & David A. Wise, 1998. "Individual Financial Decisions in Retirement Saving Plans and the Provision of Resources for Retirement," NBER Chapters, in: Privatizing Social Security, pages 363-401 National Bureau of Economic Research, Inc.
- Willis, Robert J., 1999. "Theory confronts data: how the HRS is shaped by the economics of aging and how the economics of aging will be shaped by the HRS," Labour Economics, Elsevier, vol. 6(2), pages 119-145, June.
- Heckman, James J & Willis, Robert J, 1977.
"A Beta-logistic Model for the Analysis of Sequential Labor Force Participation by Married Women,"
Journal of Political Economy,
University of Chicago Press, vol. 85(1), pages 27-58, February.
- James J. Heckman & Robert J. Willis, 1975. "A Beta-Logistic Model for the Analysis of Sequential Labor Force Participation by Married Women," NBER Working Papers 0112, National Bureau of Economic Research, Inc.
- Chris Starmer, 2000. "Developments in Non-expected Utility Theory: The Hunt for a Descriptive Theory of Choice under Risk," Journal of Economic Literature, American Economic Association, vol. 38(2), pages 332-382, June.
- Arulampalam, W. & Robin A. Naylor & Jeremy P. Smith, 2002. "University of Warwick," Royal Economic Society Annual Conference 2002 9, Royal Economic Society.
- James P. Smith, 2004.
"Inheritances and Bequests,"
Labor and Demography
- Johnson, William R, 1978. "A Theory of Job Shopping," The Quarterly Journal of Economics, MIT Press, vol. 92(2), pages 261-78, May.
- Gilboa, Itzhak & Schmeidler, David, 1989. "Maxmin expected utility with non-unique prior," Journal of Mathematical Economics, Elsevier, vol. 18(2), pages 141-153, April.
- Rothschild, Michael & Stiglitz, Joseph E., 1970. "Increasing risk: I. A definition," Journal of Economic Theory, Elsevier, vol. 2(3), pages 225-243, September.
- Dohmen, Thomas J & Falk, Armin & Huffman, David & Sunde, Uwe, 2008.
"Are Risk Aversion and Impatience Related to Cognitive Ability?,"
CEPR Discussion Papers
6852, C.E.P.R. Discussion Papers.
- Thomas Dohmen & Armin Falk & David Huffman & Uwe Sunde, 2010. "Are Risk Aversion and Impatience Related to Cognitive Ability?," American Economic Review, American Economic Association, vol. 100(3), pages 1238-60, June.
- Thomas Dohmen & Armin Falk & David Huffman & Uwe Sunde, 2009. "Are Risk Aversion and Impatience Related to Cognitive Ability?," CESifo Working Paper Series 2620, CESifo Group Munich.
- Dohmen, Thomas & Falk, Armin & Huffman, David B. & Sunde, Uwe, 2007. "Are Risk Aversion and Impatience Related to Cognitive Ability?," IZA Discussion Papers 2735, Institute for the Study of Labor (IZA).
- Dohmen, Thomas J & Falk, Armin & Huffman, David & Sunde, Uwe, 2007. "Are Risk Aversion and Impatience Related to Cognitive Ability?," CEPR Discussion Papers 6398, C.E.P.R. Discussion Papers.
- Thomas Post & Katja Hanewald, 2011.
"Longevity Risk, Subjective Survival Expectations, and Individual Saving Behavior,"
201111, ARC Centre of Excellence in Population Ageing Research (CEPAR), Australian School of Business, University of New South Wales.
- Post, Thomas & Hanewald, Katja, 2013. "Longevity risk, subjective survival expectations, and individual saving behavior," Journal of Economic Behavior & Organization, Elsevier, vol. 86(C), pages 200-220.
- Dohmen Thomas & Falk Armin & Huffman David & Sunde Uwe, 2009. "Are Risk Aversion and Impatience Related to Cognitive Ability?," ROA Research Memorandum 007, Maastricht University, Research Centre for Education and the Labour Market (ROA).
- Herings P. Jean-Jacques & Predtetchinski Arkadi, 2009. "Bargaining with Non-convexities," Research Memorandum 042, Maastricht University, Maastricht Research School of Economics of Technology and Organization (METEOR).
- Andrew M. Parker & Leandro S. Carvalho & Susann Rohwedder, 2013. "Cognitive Ability, Expectations, and Beliefs about the Future: Psychological Influences on Retirement Decisions," Working Papers wp298, University of Michigan, Michigan Retirement Research Center.
- Adeline Delavande & Susann Rohwedder, 2008. "Differential Mortality in Europe and the U.S.: Estimates Based on Subjective Probabilities of Survival," Working Papers 613, RAND Corporation Publications Department.
- Gábor Kézdi & Robert J. Willis, 2003. "Who Becomes a Stockholder? Expectations, SUbjective Uncertainty, and Asset Allocation," Working Papers wp039, University of Michigan, Michigan Retirement Research Center.
- Wändi Bruine de Bruin & Andrew Parker & Jürgen Maurer, 2011. "Assessing small non-zero perceptions of chance: The case of H1N1 (swine) flu risks," Journal of Risk and Uncertainty, Springer, vol. 42(2), pages 145-159, April.
- Todd Elder, 2007. "Subjective Survival Probabilities in the Health and Retirement Study: Systematic Biases and Predictive Validity," Working Papers wp159, University of Michigan, Michigan Retirement Research Center.
- Steven Haider & Mel StephensJr., 2006. "How Accurate are Expected Retirement Savings?," Working Papers wp128, University of Michigan, Michigan Retirement Research Center.
- Borghans Lex & Cörvers Frank, 2009. "The Americanization of European Higher Education and Research," ROA Research Memorandum 010, Maastricht University, Research Centre for Education and the Labour Market (ROA).
- Daniel J. Benjamin & Sebastian A. Brown & Jesse M. Shapiro, 2006. "Who is “Behavioral”? Cognitive Ability and Anomalous Preferences," Levine's Working Paper Archive 122247000000001334, David K. Levine.
- John Ameriks & Andrew Caplin & Steven Laufer & Stijn Van Nieuwerburgh, 2007. "The Joy of Giving or Assisted Living? Using Strategic Surveys to Separate Bequest and Precautionary Motives," NBER Working Papers 13105, National Bureau of Economic Research, Inc.
- Claudia R. Sahm, 2007. "Stability of risk preference," Finance and Economics Discussion Series 2007-66, Board of Governors of the Federal Reserve System (U.S.).
- Adeline Delavande & Hans-Peter Kohler, 2009. "Subjective expectations in the context of HIV/AIDS in Malawi," Demographic Research, Max Planck Institute for Demographic Research, Rostock, Germany, vol. 20(31), pages 817-875, June.
- Adeline Delavande & Susann Rohwedder, 2008. "Eliciting Subjective Expectations in Internet Surveys," Working Papers 589, RAND Corporation Publications Department.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (MRRC Administrator).
If references are entirely missing, you can add them using this form.