In life, risk is reward and vice versa. Unfortunately, the big rewards people desire are relatively unlikely to occur. This relationship between risk and reward or probabilities and payoffs seems obvious to the financial community and to laypeople alike. Yet theories of decision making have largely ignored it. We conducted an ecological analysis of life’s gambles, ranging from the domains of roulette and life insurance to scientific publications and artificial insemination. Across all domains, payoffs and probabilities proved intimately tied, with payoff magnitudes signaling their probabilities. In some cases, the constraints of the market result in these two core elements of choice being related via a power function; in other cases, other factors such as social norms appear to produce the inverse relationship between risks and rewards. We offer evidence that decision makers exploit this relationship in the form of a heuristic—the risk–reward heuristic—to infer the probability of a payoff during decisions under uncertainty. We demonstrate how the heuristic can help explain observed ambiguity aversion. We further show how this ecological relationship can inform other aspects of decision making, particularly the approach of using monetary lotteries to study choice under risk and uncertainty. Taken together, these findings suggest that theories of decision making need to model not only the decision process but also the environment to which the process is adapted.
Read Here: https://psycnet.apa.org/record/2014-26582-001?doi=1
Citation: Pleskac, T. J., & Hertwig, R. (2014). Ecologically rational choice and the structure of the environment. Journal of Experimental Psychology: General, 143(5), 2000–2019. https://doi.org/10.1037/xge0000013