Improve Your Odds by Staying Cool in the Face of Crisis
Thinking in bets and using the base case are two keys to success
A summer hurricane is bearing down. Mild panic ensues. Events are canceled. Some businesses begin boarding up. Parents race to get their children from school.
I see the town’s public works director, Barry, at the local hardware store. He is buying some supplies on his way to the emergency operations center. I am buying a new blade for my lawnmower.
“It is going to be a bad one!” explained Barry. “We are closing down the Town; it is going to rain more than six inches!”
“Want to bet?” I countered. “Over-under four inches. I will take the under.”
The wager ended up as a bottle of whiskey. Payable one week after the storm.
The Bet
I work with infrastructure and the environment enough to know that summer hurricanes usually weaken before landfall. In fact, our area has not had more than two inches of rain in a 24-hour period from an August hurricane (or tropical storm) in more than 40 years. That is also known as the “base case.” I decided on the fly to double it to account for probability theory and a little for climate change. It makes for a good bet because Barry believes a Weather Channel prediction of at least six inches of rain.
Perceptions of Risk
People tend to overweight unlikely events and overestimate the probability of their occurrence. Overestimation is especially true if the decision maker feels out of control and potentially directly or disproportionately impacted by the event. The more vivid the description of a rare event is made to be, the more it is either feared or desired (like winning the lottery). Vividness is one reason for the availability bias when planning for potential rare events like tornados or terrorism if such events have recently occurred and are heavily publicized. It is also the reason fear is a popular line of messaging in a political advertisement — the more negative expectations established in the public’s mind, the more a given rare event will be over-weighted and the likelihood of the potential occurrence will be overestimated.
“Subjective judgments are made at every stage of the assessment process.” — Slovic and Weber
Elected officials are overly cautious because there is a steep political downside for being wrong. The Weather Channel benefits from the hype, so a larger viewing area means more people tuning in and more advertising dollars. Plus, people remember when they are disappointed — I will forget that you predicted rain when it was sunny because I was happy, but I will remember when you predicted it would be sunny and it rained because I was unhappy when my plans were ruined. Politicians and people who depend on satisfied customers have skin in the game. Remember, all risk is personal.
Academic Traditions
Risk is more subjective than objective. It is a concept invented by human beings to help understand and cope with the dangers and uncertainties of life. According to Paul Slovic and Elke Weber, “Subjective judgments are made at every stage of the assessment process, from the initial structuring of a risk problem to deciding which endpoints or consequences to include in the analysis, identifying and estimating exposures, choosing dose-response relationships, and so on.”
Another foundational observation from Slovic’s classic paper “Trust, Emotion, Sex, Politics, and Science: Surveying the Risk‐Assessment Battlefield” is “Danger is real but risk is socially constructed.” Risk associated with rare events impacts different people in different ways. Communicating both before and after a rare event is shaped by personal experience and perceptions.
“Risk does not exist ‘out there,’ independent of our minds and cultures, waiting to be measured.” — Slovic and Weber
In Daniel Kahneman & Amos Tversky’s Prospect Theory, humans tend to be influenced by their expectations and emotions and make decisions under uncertainty that may be mathematically illogical. Prospect Theory is an alternative for the traditional decision-making theory, Utility Theory, which maintains that the decision maker acts on objective differences by using criteria (importance) weighting that matches the likelihood of the criteria occurring. In Prospect Theory, decision making is based more on perceived upsides and downsides than absolute differences in value under Utility Theory.
Kahneman’s Fourfold Pattern relates specifically to the combination of low and high likelihood related to high and low consequences (gains or losses). If the future likelihood of the event is perceived to be small but the potential loss is high (a rare event), then a decision maker with a low risk tolerance may act to avoid the event at all costs. A simple example is a politician who is willing to spend a disproportionate amount of taxpayer money to avoid the potential impacts of a natural disaster, terrorist attack, or pandemic. However, suppose the same politician perceives that the consequences are overstated or can control the mitigation of future events. In that case, fewer resources will be allocated to the potential rare event.
“Danger is real but risk is socially constructed” — Paul Slovic
Another way to look at rare events is based on choices from experience. People have often been affected differently from past rare events and therefore assign different probabilities and weightings in making their decisions. The perceptions matter more than the actual probabilities.
The Result
It rained 3.5 inches. I won the bet. I had dug deeper into the data. I had listened less to the hype.
I suspected that I could have set the over/under at 5 inches and Barry would have taken it. I did not, in part, because he could have made me take the over 5 inches. Barry did not negotiate the terms of the bet. Barry took the bet without considering the base case. Win or lose, I learned a lot about how Barry evaluated risk.
The whiskey tasted good.
Danger is real but risk is socially constructed. Stay cool in the face of crisis.
