Cognitive Foundations Of Risk Judgments

Gerd Gigerenzer

Max Planck Institute for Human Development Berlin

Whenever the people are well-informed, they can be trusted with their own government.

Thomas Jefferson

RISK VS UNCERTAINTY

RISK: How should we make decisions when all relevant alternatives,

consequences, and probabilities are known?

Statistical thinking, logic

UNCERTAINTY:

How should we make decisions when NOT all alternatives, consequences, and probabilities are known?

Heuristic thinking, intuition

Gigerenzer, Hertwig & Pachur Eds. 2011. Heuristics: The foundations of adaptive behavior. OUP

I. Dread Risk Fear

Terrorists’ Second Strike

1,500 Americans lost their lives on the road by trying to avoid the risk of flying

Gigerenzer 2006, Risk Analysis

About 1,600 Americans died on the roads in the attempt to avoid the risk of flying

Gigerenzer 2006, Risk Analysis

Dread Risk Fear

Structure of the environment:

1. Humans live in small groups 2. Constant threat to survival

Heuristic:

If many people die at one point in time, react with fear and avoid that situation.

Gigerenzer 2006, Risk Analysis

II. The Illusion of Certainty

Complex Problems Do Not Require Complex Solutions

Predictions by 22 international banks, including Bank of America Merrill Lynch, Bank of Tokyo Mitsubishi, Barclays Capital, Citigroup, Commerzbank, Credit Suisse, Deutsche Bank, HSBC, JP Morgan,

Merrill Lynch, Morgan Stanley, and Societé Générale. Source: Gigerenzer (in press). Risk savvy. Viking. Based on ConsensusEconomics, 2001-2010

Predictions by 22 international banks, including Bank of America Merrill Lynch, Bank of Tokyo Mitsubishi, Barclays Capital, Citigroup, Commerzbank, Credit Suisse, Deutsche Bank, HSBC, JP Morgan,

Merrill Lynch, Morgan Stanley, and Societé Générale. Source: Gigerenzer (in press). Risk savvy. Viking. Based on ConsensusEconomics, 2001-2010

How to make investment decisions?

Harry Markowitz

Optimal Asset Allocation Policy “Mean-Variance-Model”

Optimization or Heuristic?

Harry Markowitz

1/N Allocate your money equally

to each of N funds

Optimal Asset Allocation Policy “Mean-Variance-Model”

When Is 1/N Better Than Mean-Variance?

Harry Markowitz

1/N is ecologically rational if:

1. Predictive uncertainty: large 2. N: large 3. Learning sample: small

DeMiguel et al., 2009, Review of Financial Studies

10/2007

55

60

65

70

75

One-Good-Reason

Tallying (1/N)

Multiple Regression

Minimalist

Hindsight Prediction

20 Studies: Robust Prediction by Ignoring Information

Accuracy (% correct)

Czerlinski, Gigerenzer, & Goldstein (1999)

Applying Models of Risk to Uncertainty Creates Illusory Certainty OPTIMALITY

Optimal under risk is not optimal under uncertainty. “VALUE AT RISK” MODELS PROVIDE ILLUSORY CERTAINTY Confusing risk with uncertainty was one of the causes of the financial crisis. E.g., David Viniar, CFO Goldman Sachs: unexpected “25-sigma events” SIMPLE HEURISTICS FOR A SAFER WORLD Complex problems (e.g. reducing the chance of another financial crisis) do not require complex solutions (e.g. Basel II and III). In a project with the Bank of England, we investigate robust regulatory heuristics. Haldane, A. G. “The Dog and the Frisbee”.

Federal Reserve Bank Economic Policy Symposium, Jackson Hole, August 31, 2012. www.bankofengland.co.uk

III. Risk Savvy Citizens

We Need to Teach the Public (and Experts) How to Deal With Risk and Uncertainty

Risk Literacy Efficient health care requires informed doctors and patients.

Problem: Most patients do not understand health statistics. Most physicians do not understand health statistics.

Causes: - We teach children the math of certainty, not that of uncertainty. - Failure of medical (and law) schools to teach statistical thinking. - Biased reporting in journals, patient pamphlets and the Internet.

Solution: Teach risk literacy, from elementary school to medical school.

Reduce biased communication of risks to the public.

Gigerenzer & Muir Gray (Eds). Better doctors, better patients, better decisions. MIT Press 2012.

"I had prostate cancer, five, six years ago. My chances of surviving prostate cancer and thank God I was cured of it, in the United States, 82 percent. My chances of surviving prostate cancer in England, only

44 percent under socialized medicine.”

Rudy Giuliani, New Hampshire radio advertisement, October 2007

Lead Time Bias

Gigerenzer, Gaissmaier, Kurz-Milcke, Schwartz, & Woloshin 2007. Psychological Science in the Public Interest.

Overdiagnosis

Gigerenzer, Gaissmaier, Kurz-Milcke, Schwartz, & Woloshin 2007. Psychological Science in the Public Interest.

Confusion about progress against cancer. Unwarranted enthusiasm for medical center.

Deception by Medical Institutions One of the most prestigious cancer centers in the US: M. D. Anderson

412 primary-care physicians (national sample)

Survival rates: 83% judged mortality benefit as large Mortality rates: 28% judged mortality benefit as large

Which proves that a cancer screening test “saves lives”?

1. Screen-detected cancers have better 5-year survival. 76% 2. More cancers are detected in screened populations. 47% 3. Mortality rates are lower among screened persons. 81%

Wegwarth, Schwartz, Woloshin, Gaissmaier & Gigerenzer, Annals of Internal Medicine, 2012.

Do U.S. Physicians Understand 5-Year Survival Rates?

65 physicians (internal medicine)

When the (same) information was framed as

Survival rates: 79% judged screening as effective Mortality rates: 5% judged screening as effective

Lead-time-bias? 2 out of 65 knew Overdiagnosis? 0 out of 65 knew

Wegwarth, Gaissmaier & Gigerenzer, Medical Decision Making, 2011

Do German Physicians Understand 5-Year Survival Rates?

Djulbegovic et al British Medical Journal 2010 Woloshin & Schwarz Journal of the National Cancer Institute 2009

PSA-Tests for 10 Years:

1.000 men 55+ 1.000 men 55+ NO Screening Screening

Benefit? total mortality 200 200

prostate cancer mortality 7-8 7-8 Harm? false positive/biopsy

-- 150-200

unnecessary treatment -- 10-30

Tansparent Risk Communication: Fact Box For Prostate Cancer Screening

www.harding-center.de

Risk Savvy

1. DREAD RISK FEAR. Allows terrorists to strike twice, first using physical force, second by using our brains.

2. ILLUSION OF CERTAINTY. The widespread use of models of risk (e.g. “value at risk”) in an uncertain world is not the solution but part of the problem.

3. RISK SAVVY CITIZENS are the fuel of a participatory democracy. We don’t need more nudging and paternalism. But we won’t get risk savvy citizens unless we start teaching the next generation.

Gigerenzer G. 2008. Rationality for Mortals. OUP Gigerenzer (in press). Risk savvy. How to make good decisions. NY Penguin.

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