Psychology of Risk 20091009

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Liverpool John MooresUniversity

Faculty of Technology & Environment

School of the Built Environment, Liverpool, UK

The Psychology of Risk

Lecture 20091009

Dr Wilfred M. Matipa


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Liverpool John Moores University

Faculty of Technology & Environment school of the Built Environment

Why study Psychology?

Risk Management is shaped by the decisionsthat humans have to make

The decision process is characterised by 2important schools of thought

Decision Theory

Prospect Theory

We need a proper understanding of how humans

make risk judgements in various situations This helps us consider the usefulness of

various risk management strategies


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Something to think about

Understanding risk taking such as gambling,potholing and driving represent one of the mostperplexing problems in the field of psychology.

The need for safety (physical, financial etc) isfundamental, are people who take huge riskstherefore illogical or even mentally ill?

Recent research suggests that normal people aremotivated to take risks as a result of theirpsychological makeup and the nature of thesituation they find themselves in


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Concepts: Framing (1) The process of defining a problem setting

boundaries too!!

Framing is a fundamental problem with allforms of risk assessment.

In particular, because of bounded rationality(our brains get overloaded, so we take mentalshortcuts) the risk of extreme events isdiscounted because the probability is too lowto evaluate intuitively.

As an example, one of the leading causes ofdeath is road accidents caused by speeding -partly because any given driver frames theproblem by largely or totally ignoring the riskof a serious or fatal accident


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Concepts: Framing (2)

Many of you may have wondered what the point ofstudying Systems Theory

Bounded rationality is a fundamental problem in risk

and we considered this in the context of closed andopen systems

Developed by the Chicago School of the 1950s and1960s

Many definitions of what bounded rationality is Decision making that takes place within an environment of

incomplete information and uncertainty

A form of behaviour associated with uncertainty where individualsdo not examine every possible option open to them, but simply

consider a number of alternatives which happen to occur to them

Complexity TheoryIssue!!


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What factors will affect theframing process?

Cultural Bias

Cognitive Bias

NotationalBias


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Some typical elements of cognitive biases

Retrospective (Hindsight) bias sometimes called the "I-knew-it-all-along" effect, is the inclination to see past eventsas being predictable

Confirmation bias the tendency to search for or interpretinformation in a way that confirms one's preconceptions.

Self-centeredbias the propensity to claim moreresponsibility for successes than failures (gamblers again!!).It may also manifest itself as a tendency for people to

evaluate ambiguous information in a way beneficial to theirinterests.

The social scientists continue to explore other types!!!


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The impact of cultural biases on the framing theproblem

Cultural biases are introduced by the intuitive thoughtprocesses and ways of doing things that are associated

with a certain culture Culture can be taken to mean anything from nationality to

organisational

The problems of cultural bias is central to many schools ofthought difficult to model though!!

In Philosophy, this subject has raised many discussionsparticularly regarding the notion that a willingness tochallenge - That is, whether people who violated the normswere "crazy.


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And finally notational biases This sounds rather esoteric but makes perfect sense when

you think about it

Terms used to describe a problem may affect ourunderstanding we touched upon this when discussingdifferences between briefing and project definition

Semantics

How do we intuitively interpret information which is given tous this element of differentiation is the essence ofnotational bias


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Problem Solving

Framing the problem

Defining the problem

Identifying and evaluating optionsavailable for solving the problem

Deciding which of the options

provides the best solution inthe circumstances

ImplementationFeedback


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Concepts: Regret

Regret is a concept that is wellversed in Decision Theory whichwe shall cover in a sec

A theory that states that humansintuitively anticipate regret if theymake a wrong choice,

They take this anticipation intoconsideration when makingdecisions.

Fear of regret can play a large role indissuading or motivating someone todo something.


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Decision Theory

Decision Theories can help us understand therisk taking/averting process

Decision Theory can be qualitative (social

science application) and quantitative (maths,stats and economics)

Decision Support Theories/Tools/Softwarehave been developed to help solve complexproblems


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Decision Theory: Fundamentals

Decision Theories relate to the choice of ONEindividual

The other theory involving multiple individuals

is Game Theory The most famous example of Game Theory

is the Prisoners Dilemma

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The most widely used form of decision theoryargues that preferences among risky alternativescan be described by the maximization the expectedvalue of a numerical utility function (money etc.)

Probability theory is heavily used in order torepresent the uncertainty of outcomes, and BayesLaw is frequently used to model the way in whichnew information is used to revise beliefs.

Decision theory is often used in the form of decision

analysis, which shows how best to acquireinformation before making a decision

Decision Theory

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Bayesian Statistics relate to the School of the thought ofEnglish Statistician Thomas Bayes

Considers what degree of confidence we may have, invarious possible conclusions, based on the body ofevidence available (risk/uncertainty)

Consider several alternative hypotheses we test them by predicting consequences of each one, then

conducting experimental tests to observe whether or not thoseconsequences actually occur.

If an hypothesis predicts that something should occur, and thatthing does occur, it strengthens our belief in the truthfulness of thehypothesis.

Conversely, an observation that contradicts the prediction wouldweaken (or destroy) our confidence in the hypothesis

An aside..Bayesian Theories

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Decision Theory

Decision Theory

DecisionTheory underUncertainty

DecisionTheory underRisk

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Decision Theory Under Uncertainty

Two approaches to decision making underuncertainty Optimistic Decision

a decision maker considers the best possible outcome for each

course of action, and chooses the course of action thatcorresponds to the best of the best possible outcomes

Pessimistic Decision

used by a pessimistic decision maker who wants to make aconservative decision. Basically, the decision rule is toconsider the worst consequence of each possible course of

action and chooses the one that has the least worstconsequence.

Li l J h M U i it


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Decision Theory Under Uncertainty -Optimistic

Choices Profit

Strong market Fair market Poor market

invest 8000 800 200 -400

invest 4000 400 100 -200

invest 2000 200 50 -100

invest 1000 100 25 -50



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Decision Theory Under Uncertainty -Pessimistic

Options Profit


invest 8000 800 200 -400

invest 4000 400 100 -200

invest 2000 200 50 -100

invest 1000 100 25 -50



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Regret is also a decision route!

The difference between what we actually get, and thebetter position that we could have got if a differentcourse of action had been chosen.

Regret is sometimes also called "opportunity loss

Select the option which presents the minimum regret



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Choices Regret


invest 8000 0 0 350

invest 4000 400 100 150

invest 2000 600 150 50

invest 1000 700 175 0



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Decision Theory Under Risk

When we are dealing with a decision where thepossible outcomes are given specific probabilities,we say that this a case of decision making underrisk.

In such situations the principle of expected value isused. We calculate the expected value associatedwith each possible course of action, and select thecourse of action that has the highest expected value.

To calculate the expected value for a course of

action, we multiple each possible payoff associatedwith that course of action with its probability, andsum up all the products for that course of action.



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Decision Theory Under Risk

Choices Profit expected value

Strong market(probability =0.1)

Fair market(probability= 0.5)

Poor market(probability =0.4)

invest8000

800 200 -400800x0.1+200x0.5+(-400)x0.4=20

invest

4000

400 100 -200400x0.1+100x0.5+(-

200)x0.4=10invest2000

200 50 -100200x0.1+50x0.5+(-100)x0.4=5

invest1000

100 25 -50100x0.1+25x0.5+(-50)x0.4=2.5



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In Context

Dealing with risk decisions is strongly correlated tothe subjective opinions of humans

In construction, risk decisions are made daily suchas when to order material deliveries

Is it maths, experience or a combination

Try to keep this in mind as we progress through themodule



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Key References

1. Kelly, Male and Graham (2004) Value Management of ConstructionProjects, Blackwell

2. Smith, N. J. (1999) Managing Risk in Construction Projects

3. Boussabaine and Kirkham (2003) Whole Life Cycle Costing: Riskand Risk Responses, Blackwell

4. Godfrey, P.S (1996) 'Control of risk: :a guide to the systematicmanagement of risk from construction: SP125' ConstructionIndustry Research Info' Assoc.

5. Chapman C B & Ward S (1997) 'Project Risk Management' Wiley

6. Akintoye, A. (2003) Public Private Partnerships: Managing Risksand opportunities, Blackwell

7. Flanagan, R (1993) Risk Management for Construction, Blackwell

8. Kelly (ed) (2002) Best Value in Construction, Blackwell

Psychology of Risk 20091009

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