Incentives to support decision-making (Part I)

There is one gambling experiment conducted by behavioural economists. The subject starts with no money and is told that he has two choices. He can choose a 50/50 gamble, where the winnings would be either 0$ or 20$, or he can choose to go home and receive a guaranteed 10$. The EV of these two offers is clearly the same, and you can probably guess right away that the vast majority chose the guaranteed 10$. So it seems to beg the conclusion that people are risk averse.

Let's now turn to some variables. Let's say that instead of starting with no money, subjects start with 20$. Again, they are told that they have two choices, to gamble 50/50 to keep or lose it all, or they can accept the loss of 10$ and keep the remaining 10$. What do you think the majority chose? In a place like this, most people chose to gamble and try to keep everything. So maybe they are willing to take some risks.

But if you're a perceptive researcher, you'll notice that both experiments have the same results. In both cases, if you choose to gamble with a 50/50 chance of winning, you will come out with either 20$ or 0$, and if you refuse, you will get 10$ in both cases. Not only the EV but also the actual results are equivalent. However, in one case people choose to forgo risk, in the other they seek it. Why?

We could say that humans are not rational beings, but that does not give us any useful information, but only removes the whole picture. We would be better off if we concluded that there is an important reason for this behaviour. Basically, risk aversion means that the magnitude of a particular gain is less satisfying than the pain caused by a loss. An example from poker: when you are faced with a flip choice that gives you a small +EV, and the flip is so big that it gives you a piss, you will always refuse it. But this decision is not necessarily irrational - you are simply optimising your feelings instead of your money. In the same way, subjects respond rationally to their incentives - their incentives maximise their feelings because the EV is exactly the same.

These experiments show the power of rephrasing, presenting something as an achievement or defeat, but there are more subtle conclusions. You may have noticed that at the start of each experiment, a different amount of money was given. Of course, the initial amount was immaterial. But if you tell a participant to start with 20$ rather than 0$, it gives the person a reference point. Such reference points are the mental and emotional anchors by which we orient ourselves. They set the initial conditions, such as the opening chapter of a book. By controlling the reference points, we can control the frame of mind through which we see objects or situations.

Even experts are sometimes swayed by such reference points. In one experiment, professionals in the medical world were offered hypothetical procedures with a "90% chance of 5-year survival" or a "10% chance of death within 5 years". Although this was essentially the same information, the experts reacted very differently, obviously choosing the 90% survival option.

The way in which information is presented strongly influences our reactions. Paraphrasing and correcting points of reference is a common tactic in advertising and politics, as well as in rhetoric and persuasion. However, we will limit our exploration to poker, making decisions based on money and EV.

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