The influence of personal characteristics on decision-making in situations of uncertainty

By omersimanovsky December 24, 2024 3 min read

In situations of uncertainty, investment decisions are made based on assessments of the chances of success on the one hand and failure or loss on the other. When there is a possibility of loss in any investment, decisions are also influenced by the nature of the decision maker. To what extent is he mentally and financially prepared to take risks. We will clarify the issue with the help of examples.

Personality Traits: “Risk Averse” vs. “Risk Lover”

A person has 100 NIS and can buy a lottery ticket with this amount. The winning amount is 200 NIS and the chance of winning is 50%. That is, half of the people who buy the ticket win 200 NIS and half do not win (and lose all their money). A “risk-averse” person will not buy the ticket, because he would rather stay with 100 NIS in his pocket than lose it. (The temptation to end up with 200 NIS in his pocket does not “work” for him.) If the person “loves risk”, the temptation of profit will make him buy the lottery ticket (the chance of losing 100 NIS does not deter him).

What would you, the reader, choose? The answer depends on your attitude towards risks.
Are you a risk averse or a risk lover?
Let’s say you’re risk averse. That is, you wouldn’t buy the lottery ticket under the current conditions. Now, let’s try to examine in 2 scenarios what you would do if the conditions changed in your favor.

Scenario 1 : The amount of the prize will increase from 200 NIS to 200,000 NIS. (And the chance of winning will remain 50%). Will the fear of losing still be stronger than the temptation of winning?

Scenario 2 : The winning amount will remain 200 NIS, but the chance of winning will increase to 99%, meaning that you will almost certainly win. Would you still choose not to buy the ticket?

If these changes in the lottery terms have not yet changed your decision (not to buy the ticket), then you are very, very risk-averse. Now let’s assume that you are risk-averse. That is, you would have bought the lottery ticket under the original terms. We will examine how you would behave in 2 scenarios in which the terms change to your detriment.

Scenario 1: The winning amount dropped from 200 NIS to 101 NIS. Would you still buy the ticket then?

Scenario 2: The amount will remain 200 NIS but the chance of winning drops to 1% (you will almost certainly lose). Would you still buy the ticket then? If so, then you really like to take risks, and it is possible that the risk itself provides you with benefits beyond the financial benefit of winning.

We have seen, therefore, that the decision whether to take a risk or not is not an objective one and varies from person to person according to their character. However, in order for a person to make a decision that is in line with their character, they must be able to objectively analyze the chance of success and the amount of money that goes with it, in relation to the chance of failure and the financial loss involved.

For example: The chance of earning 100 NIS is 60%
And the chance of losing 100 NIS is 40%,
So objectively it’s worth participating in the lottery.

And if for example: the chance of earning 1000 NIS is 20%
And the chance of losing 1000 NIS is 80%, it’s not worth participating.

In the example above, we assumed that there were only 2 options:

earn
lose

Next to each option is its probability. In most cases there are more than 2 options as shown in the following example (4 options):

Win 10,000 NIS – 5% chance.
Win 5,000 NIS – 10% chance.
Win 100 NIS – 20% chance.
Losing 100 NIS – 65% chance.

To decide whether to participate in a lottery whose results are the above 4 options, it is customary to calculate the expected profit, which we will expand on below.

The influence of personal characteristics on decision-making in situations of uncertainty

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