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Underweighting Rare Events in Experience Based Decisions: Beyond Sample Error

Author

Listed:
  • Greg Barron

    () (Harvard Business School)

  • Giovanni Ursino

    () (DISCE, Università Cattolica)

Abstract

Recent research has focused on the "description-experience gap": While rare events are overweighted in description based decisions, people tend to behave as if they underweight rare events in decisions based on experience. Barron and Erev (2003) and Hertwig, Barron, Weber, and Erev (2004) argue that such findings are substantive and call for a theory of decision making under risk other than Prospect Theory for decisions form experience. Fox and Hadar (2006) suggest that the discrepancy is due to sampling error: people are likely to sample rare events less often than objective probability implies, especially if their samples are small. The current paper examines the necessity of sample error in the underweighting of rare events. The first experiment shows that the gap persists even when people sample the entire population of outcomes and make a decision under risk rather than under uncertainty. A reanalysis of Barron and Erev (2003) further reveals that the gap persists even when subjects observe the expected frequency of rare events. The second experiment shows that the gap exists in a repeated decision making paradigm that controls for sample biases and the "hot stove" effect. Moreover, while underweighting persists in actual choices, overweighting is observed in judged probabilities. The results of the two experiments strengthen the suggestion that descriptive theories of choice that assume overweighting of small probabilities are not useful in describing decisions from experience. This is true even when there is no sample error, for both decisions under risk and for repeated choices.

Suggested Citation

  • Greg Barron & Giovanni Ursino, 2009. "Underweighting Rare Events in Experience Based Decisions: Beyond Sample Error," DISCE - Quaderni dell'Istituto di Economia dell'Impresa e del Lavoro ieil0054, Università Cattolica del Sacro Cuore, Dipartimenti e Istituti di Scienze Economiche (DISCE).
  • Handle: RePEc:ctc:serie4:ieil0054
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    File URL: http://www.unicatt.it/Istituti/EconomiaImpresaLavoro/Quaderni/ieil0054.pdf
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    References listed on IDEAS

    as
    1. Rakow, Tim & Demes, Kali A. & Newell, Ben R., 2008. "Biased samples not mode of presentation: Re-examining the apparent underweighting of rare events in experience-based choice," Organizational Behavior and Human Decision Processes, Elsevier, vol. 106(2), pages 168-179, July.
    2. Mohammed Abdellaoui & Olivier L'Haridon & Corina Paraschiv, 2011. "Experienced vs. Described Uncertainty: Do We Need Two Prospect Theory Specifications?," Management Science, INFORMS, pages 1879-1895.
    3. Tversky, Amos & Kahneman, Daniel, 1992. "Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
    4. Starmer, Chris & Sugden, Robert, 1991. "Does the Random-Lottery Incentive System Elicit True Preferences? An Experimental Investigation," American Economic Review, American Economic Association, vol. 81(4), pages 971-978, September.
    5. Craig R. Fox & Amos Tversky, 1998. "A Belief-Based Account of Decision Under Uncertainty," Management Science, INFORMS, vol. 44(7), pages 879-895, July.
    6. Jerker Denrell & James G. March, 2001. "Adaptation as Information Restriction: The Hot Stove Effect," Organization Science, INFORMS, vol. 12(5), pages 523-538, October.
    7. Ido Erev & Ira Glozman & Ralph Hertwig, 2008. "What impacts the impact of rare events," Journal of Risk and Uncertainty, Springer, vol. 36(2), pages 153-177, April.
    8. Holt, Charles A, 1986. "Preference Reversals and the Independence Axiom," American Economic Review, American Economic Association, vol. 76(3), pages 508-515, June.
    9. Eldad Yechiam & Greg Barron & Ido Erev, 2005. "The Role of Personal Experience in Contributing to Different Patterns of Response to Rare Terrorist Attacks," Journal of Conflict Resolution, Peace Science Society (International), vol. 49(3), pages 430-439, June.
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    Cited by:

    1. Di Guida, Sibilla & Erev, Ido & Marchiori, Davide, 2015. "Cross cultural differences in decisions from experience: Evidence from Denmark, Israel, and Taiwan," Journal of Economic Psychology, Elsevier, vol. 49(C), pages 47-58.
    2. Emmanuel Kemel & Muriel Travers, 2016. "Comparing attitudes toward time and toward money in experience-based decisions," Theory and Decision, Springer, pages 71-100.
    3. Hanan Shteingart & Yonatan Loewenstein, 2016. "Heterogeneous Suppression of Sequential Effects in Random Sequence Generation, but not in Operant Learning," Discussion Paper Series dp701, The Federmann Center for the Study of Rationality, the Hebrew University, Jerusalem.

    More about this item

    Keywords

    experience-based decisions; Prospect Theory; rare event; overweighting; underweighting;

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior

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