Most research around risk attitudes covers situations with immediate consequences, where the decision-maker receives the result directly after making their choice. This applies in most gambling scenarios, where results and consequences or payouts happen immediately after playing.
Risk and time are intertwined in real-life decisions, so we decided to explore whether risk attitudes change when the moment of a decision is separated from the outcome of that choice.
In reality, the vast majority of consequences of decisions occur after a period of time, for example, finding out the result of an election or receiving a fine for exceeding a speed limit. Risk and time are intertwined in real-life decisions, so we decided to explore whether risk attitudes change when the moment of a decision is separated from the outcome of that choice.
To do this, we asked participants to decide whether they wanted to receive a fixed sum of money or enter a lottery with a chance of either getting nothing or winning a higher amount. Two different treatments were considered. In one treatment, the outcomes were paid immediately, whereas in the other treatment, the outcomes were paid one year after the decision was made.
Risk tolerance rises when consequence is delayed
Most economists assume that people are rational and will act in predictable ways. This simplification allows economists to model human decision making and anticipate behavior. This normative model of decision making states people should be equally likely to take a risk regardless of when the consequence might take place. However, our experimental observations do not agree; they reveal that actual behavior is quite different.
We found that when the lottery payment was postponed, people chose to take more risk, even if the result itself was indicated immediately after playing. Although previous research has already reported a higher risk tolerance for lotteries with delayed payment, our experiments disentangles the delay of payment, from the delay of reception of the result of the lottery: the result of the lottery was always known immediately whereas the outcome was paid either immediately or after one year.
Our results show that delaying only the payment, while sharing results of the lottery immediately, was enough to increase risk tolerance – a surprising result if we expect fully rational behavior.
As an explanation for this increase in risk tolerance, our findings suggest a higher level of optimism regarding the chances of success when consequences are delayed.
Generally, people can be more or less optimistic or pessimistic; when looking at a mixed weather forecast, an optimist might expect sunny skies, whereas a less positively inclined person may have the more pessimistic outlook that it’ll be raining all day. When considering outcomes in the future people tend to suffer from optimism bias –something that causes us to believe that outcomes will be positive and that things will work out, regardless of the fact that rationally speaking, projects inevitably run into problems.
It has been suggested that our attitude towards climate change is also influenced by optimism bias. With our new research, we can also assume that because the major consequences of climate change will be delayed, people are more likely to take risks with regards to the environment.
We must be aware of both optimism bias and the increase in risk tolerance with delayed consequences to avoid unexpected future consequences.
Another example of optimism bias can be seen with adolescent smokers, who are two and a half times more likely than non-smokers to doubt that they would ever die from smoking even if they smoked for three or four decades. Considering the issues of smoking or climate change, this optimism bias could have deadly consequences.
Climate change is far from winning the lottery – it introduces us to new dangers and risks that we have never seen the likes of. Our research only analyzed situations with a non-negative result, which naturally leads to the question of whether the same increase in risk tolerance and optimism would be recorded when participants face a potential loss. In reality, risky situations are usually associated with potential losses, so analyzing this can better help to understand biases in real-life situations like investment decisions and insurance.
Our research has captured and recorded biases when people make decisions, but future studies could be key to discovering how these biases can surface and how we can manage them appropriately to ensure we make more rational decisions. This could also allow better models of human behavior to be created for economists.
Inconsistency in choice and preferences can lead to tumultuous risk attitudes.
*Learn more about the impact of other biases on investors in this article by HEC Paris Professor Thomas Astebro in this Knowledge@HEC article.