A deeper understanding of judgments and choices also requires a richer vocabulary than is available in everyday language. The hope for informed gossip is that there are distinctive patterns in the errors people make...When the handsome and confident speaker bounds onto the stage, for example, you can anticipate that the audience will judge his comments more favorably than he deserves...the availability of a diagnostic label for this bias - the halo effect - makes it easier to anticipate, recognize, and understand.
Although Kahneman draws only modest policy implications (e.g., contracts should be stated in clearer language), others — perhaps overconfidently? — go much further. Brooks, for example, has argued that Kahneman and Tversky’s work illustrates “the limits of social policy”; in particular, the folly of government action to fight joblessness and turn the economy around.
Some of the problems of interpreting human behavior in the face of risk has to do with the problem of people making decisions on the basis of subjective assessments of probabilities which may be quite different from the objective or true probabilities. Events of small probability that have never occured before may be assessed as having a probability of zero in decision-making, but this is leads to tragedies in which people find they have been playing Russian roulette without even knowing they are doing so. Small probabilities add up when chances are taken repeatedly.
One very important result of Kahneman and Tversky work is demonstrating that people's attitudes toward risks concerning gains may be quite different from their attitudes toward risks concerning losses. For example, when given a choice between getting $1000 with certainty or having a 50% chance of getting $2500 they may well choose the certain $1000 in preference to the uncertain chance of getting $2500 even though the mathematical expectation of the uncertain option is $1250. This is a perfectly reasonable attitude that is described as risk-aversion. But Kahneman and Tversky found that the same people when confronted with a certain loss of $1000 versus a 50% chance of no loss or a $2500 loss do often choose the risky alternative. This is called risk-seeking behavior. This is not necessarily irrational but it is important for analysts to recognize the asymmetry of human choices.
An optimistic temperament encourages persistence in the face of obstacles. But this persistence can be costly. A series of studies by Thomas Astebro shed light on what happens when optimists get bad news. (His data came from Canada’s Inventor’s Assistance Program -- which provides inventors with objective assessments of the commercial prospects of their ideas. The forecasts of failure in this program are remarkably accurate.)
In Astebro’s studies, discouraging news led about half of the inventors to quit after receiving a grade that unequivocally predicted failure. However, 47 percent of them continued development efforts even after being told that their project was hopeless, and on average these individuals doubled their initial losses before giving up.
The evidence suggests that an optimistic bias plays a role -- sometimes the dominant role -- whenever people or institutions voluntarily take on significant risks. More often than not, risk-takers underestimate the odds they face and, because they misread the risks, optimistic entrepreneurs often believe they are prudent, even when they are not. Their confidence sustains a positive mood that helps them obtain resources from others, raise the morale of their employees and enhance their prospects of prevailing. When action is needed, optimism, even of the mildly delusional variety, may be a good thing.
Social scientists in the 1970s broadly accepted two ideas about human nature. First, people are generally rational, and their thinking is normally sound. Second, emotions such as fear, affection, and hatred explain most of the occasions on which people depart from rationality. Our article challenged both assumptions without discussing them directly.
The two then developed an alternative account of decision making, one more faithful to human psychology, which they called “prospect theory.” (It was for this achievement that Kahneman was awarded the Nobel.) In the third phase of his career, mainly after the death of Tversky, Kahneman has delved into “hedonic psychology”: the science of happiness, its nature and its causes.
Daniel Kahneman is a Senior Scholar at the Woodrow Wilson School of Public and International Affairs. He is also Professor of Psychology and Public Affairs Emeritus at the Woodrow Wilson School, the Eugene Higgins Professor of Psychology Emeritus at Princeton University, and a fellow of the Center for Rationality at the Hebrew University in Jerusalem.
He was awarded the Nobel Prize in Economic Sciences in 2002 for his pioneering work integrating insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty. Much of this work was carried out collaboratively with Amos Tversky.