Differential effects of outcome and probability on risky decision

ABSTRACT

Decision-making under uncertainty involves two main factors: probability and pay-off (outcome). Subjective expected utility theory argues that when making choices, the decision-maker selects the alternative that maximizes expected utility. Prospect theory argues that the decision-maker chooses the alternative that maximizes weighted value. Both theories argue for a weighted measure based on which the decision-maker makes choices. Neither explains, however, how probability and pay-off affect the decision-maker in making those choices. In addition, evidence exists that shows that utility is variable in relation to lotteries or frames, but how utility changes remains unknown. In this paper, we report an experiment to address this question; that is, how does pay-off or probability affect the decision-maker in making choices under uncertainty? The results show that when faced with gains, the decision-maker pays more attention to probability, whereas when faced with losses, the decision-maker seems equally sensitive to probability and pay-off in making choices under uncertainty.

KEYWORDS:

• Gains
• losses
• outcome
• probability
• decision-making under uncertainty

JEL CLASSIFICATION:

• D81
• C44

Disclosure statement

No potential conflict of interest was reported by the authors.

Additional information

Funding

This work was supported by the Ministry of Science and Technology, Taiwan [103WFA1300061].