The Invisible Game

Chapter 15Why Equal Things Aren't Always Equal

Imagine you are confronted with the following proposition: you can either accept $1,800 with no strings attached, or you can opt for a 90% chance to win $2,000, which means you have a 10% chance of coming away empty handed. Which option would you prefer?

Now let's flip things around. This time, your two options are either to lose $1,800, or to have a 90% chance of losing $2,000, which means you have a 10% chance of suffering no loss at all. Which option would you prefer?

If you are like most people, your chosen option in both cases would reflect the natural human tendencies toward risk aversion. Humans are risk-averse when it comes to gains, but risk-seeking when it comes to losses. The usual response to the first question is to take the money and run, rather than risk that money for a somewhat larger gain. If you have spent time watching game shows, you have seen contestants wrestle with that question and have probably implored them to ‘Take the money!’ But in the second situation, people want to avoid the certain loss, and take their chances – however slight – that they might lose nothing at all. These sharp preferences hold true even though – purely mathematically speaking – there was no difference between any of the options above. Players either had an expected loss or an expected gain of $1,800.

This example derives from prospect theory, which we introduced briefly in Chapter 8, when we demonstrated with a practical example ...