Certainty and possibility

There are two irrational human tendencies about which I’ll write today. They are the Possibility Effect and the Certainty Effect.
It has been proven that humans will consistently overestimate the importance (or “weight”) of low probability events. We will also overvalue the importance of 100% certainty compared to 95% certainty for example.

This concept is a little hard to grasp, but let’s consider the idea below. If there were a 1% probability or chance of something happening in your life, you might expect that you weight that chance at 1%. In fact, meta analysis shows the that weight people usually give something with a 1% chance of happening as being more like 5.5%. Conversely, if there was a something in your life with a 99% chance of happening, you’d like to think you would weight it’s value at 99%, but you don’t. It’s far from perfectly certain in your mind and so you weight it around 91.2%

As an example, what would you rather?

A) A sure gain of $300, or
B) An 80% to win $450 (20% chance to win $0)

If you’re like most people, you’ve chosen option A, a sure gain. However, if you do the math, an 80% probability of winning $450 carries an expected value of $360 (.8 x 450). So, most people would give up an expected $60 of value just for certainty.

If we were perfectly rational people (or Homo-economicus or Econs as some refer), we would select the risky option. But we are not. This is the certainty effect: the irrational draw we have to the 100% certain.

We do a similar thing with low probability environments. As soon as something is remotely possible, we weight or value that possibility to a greater degree than we should. This Possibility Effect as Kahneman explains in his new book “Thinking, Fast and Slow” is the reason why lotteries are so popular. If we have a ticket; “… you’re sayin’ there’s a chance.” I guess Dumb and Dumber wasn’t so dumb after all.

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