A new test of the risk-reward heuristic

Abstract

Risk and reward are negatively correlated in a wide variety of environments, and in many cases this trade off approximates a fair bet. Pleskac and Hertwig (2014) recently proposed that people have internalized this relationship and use it as the basis for probability estimation and subsequent choice under conditions of uncertainty. Specifically, they showed that risky options with high-value outcomes are inferred to have lower probability than options offering a less valuable reward. We report two experiments that test a simple corollary of this idea. In both studies, participants estimated the magnitude of prizes offered by lotteries with known win-probabilities. The relationship between estimates and probabilities followed the power relationship predicted by the risk-reward heuristic, albeit with a tendency to overestimate outcome magnitude. In addition, people’s estimates predicted their willingness to take the gamble. Our results provide further evidence that people have internalized the ecological relationship between risk and reward in financial lotteries, and we suggest that this relationship exerts a wide-ranging influence on decision-making.