Risk aversion making economic decisions, certainly effect and probabilities estimation
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Abstract
It has been empirically observed that the principles of utility theory are frequently violated in decision-making in risky environments. This led to the formulation of the prospect theory. In prospect theory, in addition to taking into account the different consideration of gains and losses
(losses loom larger than gains), as well as the risk posture of decision-makers (risk aversion for gains and risk seeking for losses), the certainty
effect is framed. According to the certainty effect, decision makers tend to underestimate payments that are merely probable, compared to those
that are obtained with certainty. Allais demonstrated the irrationality that occurs in decision making in this context. On the other hand, to make
risky decisions, it is necessary to know how the probabilities work. In order to determine the relationships between risk aversion, the certainty
effect, and basic knowledge of probability theory, an experimental study was designed. In this study, it was verified, using a formulation based on the Allais paradox, that those who have greater knowledge of the principles of probability show greater aversion to risk. However, the fact of
incurring in the certainty effect is a circumstance that is not significantly affected by said knowledge.
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