Increased anxiety leads to increased reliance on biased risk taking in financial decisions. That’s according to a new study from researchers at Rutgers University.
The study was premised on an oft cited observation by Kahneman et al that people are more sensitive to potential losses than to potential gains, preferring to make riskier choices in the face of potential loss and more conservative choices in the face of potential gains. At first, this might sound counterintuitive: if people are loss averse, then why would they make riskier decisions in the face of potential loss? I should probably read the original Kahneman paper but my intuition is that because loss is so painful, people avoid it at all costs, preferring rather a low probability, large loss to more frequent but smaller one. For example, in this study, participants had to choose between a 20% chance of losing or winning $3.00 versus an 80% chance of losing or winning .75. Of course, it should quickly become obvious that neither choice is riskier than the other in other the loss or gain condition. Over repeated choices of this type, one is likely to lose or win the same amount no matter which choice is made. That being the case, we should see that people on average would choose between the two options at a rate of 50/50. But that’s not what we find. In the loss condition, subjects are more likely to choose the “risky” option, the choice with the lower probability of occurring, e.g. $3.00 at 20%.
But in the gain condition, people are more likely to choose the “conservative” option, the choice with the higher probability of occurring, e.g. .75 at 80%.
It seems that people are more sensitive to the pain of loss than they are sensitive to the reward of large gains. They would rather gain in more consistent, but smaller, increments, whereas they would prefer their losses to come less frequently, even if the loss will be bigger when it comes. Widely replicated over numerous experiments, this effect seems to be largely automatic and out of conscious awareness. The researchers posited that this effect would become even stronger under conditions of increased anxiety, as this would lead to decreased cognitive resources and increased reliance on decision making heuristics that are less cognitively demanding.