Dataset Information

The bounded rationality of probability distortion.

ABSTRACT: In decision making under risk (DMR) participants' choices are based on probability values systematically different from those that are objectively correct. Similar systematic distortions are found in tasks involving relative frequency judgments (JRF). These distortions limit performance in a wide variety of tasks and an evident question is, Why do we systematically fail in our use of probability and relative frequency information? We propose a bounded log-odds model (BLO) of probability and relative frequency distortion based on three assumptions: 1) log-odds: probability and relative frequency are mapped to an internal log-odds scale, 2) boundedness: the range of representations of probability and relative frequency are bounded and the bounds change dynamically with task, and 3) variance compensation: the mapping compensates in part for uncertainty in probability and relative frequency values. We compared human performance in both DMR and JRF tasks to the predictions of the BLO model as well as 11 alternative models, each missing one or more of the underlying BLO assumptions (factorial model comparison). The BLO model and its assumptions proved to be superior to any of the alternatives. In a separate analysis, we found that BLO accounts for individual participants' data better than any previous model in the DMR literature. We also found that, subject to the boundedness limitation, participants' choice of distortion approximately maximized the mutual information between objective task-relevant values and internal values, a form of bounded rationality.

SUBMITTER: Zhang H

PROVIDER: S-EPMC7486738 | biostudies-literature | 2020 Sep

REPOSITORIES: biostudies-literature

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The bounded rationality of probability distortion.

Zhang Hang H Ren Xiangjuan X Maloney Laurence T LT

Proceedings of the National Academy of Sciences of the United States of America 20200825 36

In decision making under risk (DMR) participants' choices are based on probability values systematically different from those that are objectively correct. Similar systematic distortions are found in tasks involving relative frequency judgments (JRF). These distortions limit performance in a wide variety of tasks and an evident question is, Why do we systematically fail in our use of probability and relative frequency information? We propose a bounded log-odds model (BLO) of probability and rela ...[more]

PMID: 32843344

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Project description:BackgroundMost economic theories are based on the premise that individuals maximize their own self-interest and correctly incorporate the structure of their environment into all decisions, thanks to human intelligence. The influence of this paradigm goes far beyond academia-it underlies current macroeconomic and monetary policies, and is also an integral part of existing financial regulations. However, there is mounting empirical and experimental evidence, including the recent financial crisis, suggesting that humans do not always behave rationally, but often make seemingly random and suboptimal decisions.Methods and findingsHere we propose to reconcile these contradictory perspectives by developing a simple binary-choice model that takes evolutionary consequences of decisions into account as well as the role of intelligence, which we define as any ability of an individual to increase its genetic success. If no intelligence is present, our model produces results consistent with prior literature and shows that risks that are independent across individuals in a generation generally lead to risk-neutral behaviors, but that risks that are correlated across a generation can lead to behaviors such as risk aversion, loss aversion, probability matching, and randomization. When intelligence is present the nature of risk also matters, and we show that even when risks are independent, either risk-neutral behavior or probability matching will occur depending upon the cost of intelligence in terms of reproductive success. In the case of correlated risks, we derive an implicit formula that shows how intelligence can emerge via selection, why it may be bounded, and how such bounds typically imply the coexistence of multiple levels and types of intelligence as a reflection of varying environmental conditions.ConclusionsRational economic behavior in which individuals maximize their own self interest is only one of many possible types of behavior that arise from natural selection. The key to understanding which types of behavior are more likely to survive is how behavior affects reproductive success in a given population's environment. From this perspective, intelligence is naturally defined as behavior that increases the probability of reproductive success, and bounds on rationality are determined by physiological and environmental constraints.

Dataset Information

The bounded rationality of probability distortion.

Publications

The bounded rationality of probability distortion.

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