Cognitive Foundations

Of Risk J udgments
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, J P 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, J P 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, J ackson 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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