Knowledge@HEC - Special Issue - 巴黎HEC商学院研究专刊 - (Page 14)

Mohammed Abdellaoui BIOGRAPHY The holder of a Ph.D. in mathematical economics and econometrics, Mohammed Abdellaoui is affiliate professor of decision science at HEC and director of research at CNRS (GREGHEC). He is the editor-in-chief of the international journal Theory and Decision. He has also won the 2009 "Decision Analysis Society Publication Award" for his publication "Loss Aversion under Prospect Theory: A Parameter-Free Measurement." Why do decision makers underestimate rare events? Uncertainty accompanies most individual and collective decisions. Given the unknown probabilities of available options, people make choices based on experience. But this way of functioning is biased: it leads to underestimating or ignoring rare events. This could explain, for example, why in 2005 only half of the colossal damage caused by the North Atlantic hurricanes in the U.S. was covered by insurance. Mohammed Abdellaoui and his co-authors set out to understand this surprising phenomenon. SUBJECTIVE PERCEPTION OF "DESCRIBED" UNCERTAINTY explain this phenomenon. In the study, when decision makers chose based on descriptions of probability distributions, they tended to feel an increase in the probability of a somewhat likely loss (50% chance of losing €1000) less strongly than the same increase in the probability of a very unlikely loss (5% risk of losing €1000 euros) or an almost certain loss (95% risk of losing €1000). This behavior is also observed for gains. In the language of prospect theory, this means that decision makers facing uncertainty overestimate small probabilities and underestimate moderate and high probabilities. The study of Abdel-laoui and his coauthors confirms this result. SMALL SAMPLES AND SHORT MEMORY PERCEPTION OF RARE EVENTS IN THE PRESENCE OF "EXPERIENCED" UNCERTAINTY The study by Mohammed Abdellaoui and his colleagues found that the behavior of decision makers depends highly on the nature of the uncertainty they are facing ("described" or "experienced"). In "experienced" uncertainty, where decision makers are unaware of probability distributions, they tend to underestimate or ignore rare events (such as very unlikely losses), in contrast to the tendency to overestimate small risks in "described" uncertainty. In the context of a risk of loss, this is equivalent to saying that decision makers are optimistic in the first case and pessimistic in the second. Three factors can 11 On the one hand, in an uncertain context, policy makers tend to trust conclusions based on very small samples: they need few examples to form an opinion. In addition, decision makers tend to draw lessons from more recent situations. For example, after a natural disaster, the inhabitants of the devastated region are often inclined to get insurance. But a significant portion of those who sign up in the immediate aftermath of the disaster will terminate their contract a few years later. PRESENTATION OF THE INFORMATION Finally, how the information is communicated influences people's perceptions. A dull description using figures presented in terms of probabilities does not have the same impact on behavior as information gained through experience. Road safety campaigns focused on communicating accident rates have little success, whereas signs indicating that fatalities have occurred at that particular location have greater impact. Besides the fact that statistics have little capacity to provoke uncertainty, they are sometimes misunderstood and misused, even by the most sophisticated decision makers. In an uncertain context, these factors contribute to incoherent decisions that may have costly negative, economic consequences. ■ Knowledge HEC

Table of Contents for the Digital Edition of Knowledge@HEC - Special Issue - 巴黎HEC商学院研究专刊

Cover
Partner companies
Table of Content
公司治理 (David Thesmar)
Corporate governance
欧洲的可再生能源 (Andrea Masini)
Renewable energies in Europe
决策 (Mohammed Abdellaoui)
Why do decision makers underestimate rare events?
建立信任 (Michel Lander)
Building trust for successful mergers and acquisitions
产品线质量的高低端延伸 (Timothy Heath)
Extending product lines up and down in quality
制度变革 (Carlos Ramirez)
Institutional change
奢侈品市场 (Anne Michaut-Denizeau)
The luxury market
创业 (Anisa Shyti)
Entrepreneurship

Knowledge@HEC - Special Issue - 巴黎HEC商学院研究专刊

Knowledge@HEC - Special Issue - 巴黎HEC商学院 研究专刊 - (Page 14)

Table of Contents for the Digital Edition of Knowledge@HEC - Special Issue - 巴黎HEC商学院 研究专刊

Knowledge@HEC - Special Issue - 巴黎HEC商学院 研究专刊

Knowledge@HEC - Special Issue - 巴黎HEC商学院研究专刊 - (Page 14)

Table of Contents for the Digital Edition of Knowledge@HEC - Special Issue - 巴黎HEC商学院研究专刊

Knowledge@HEC - Special Issue - 巴黎HEC商学院研究专刊