Managing Global Enterprise Risks

Psychological Bias to Risk Decision Making The analytical tools that we have reviewed are important to the risk management process. However the analytical tools have to be applied by humans and humans have bias that need to be understood when they are making decisions about risks. When making decisions about risks, we try very rigorously to derive a rational decision. We try to overcome the problems of poor or inadequate information, time constraints, and mathematical mistakes in arriving at our rational decision. However we can not forget to factor in this equation human nature. Our decision making behavior has distinct patterns that repeatedly appear and interferes with the ability to make rational risk decisions. These “habits of the mind” which led to the psychological biases in risk decision making were studied by Daniel Kahneman and Amos Tversky and earned them a Nobel Prize in 2002. Kahneman and Tversky experiments demonstrated that mathematical models of probability and choice don't account for most intuitive human decisions. Instead, human decisions appear to be a series of psychological principles, often leading to the problem over simplification, that guide human behavior in the face of uncertainty. Kahneman and Tversky work tried to identifying these human biases. Studying their work in this area can aid us making better risk decisions and helping us in understanding the risk decisions of others. The following psychological biases identified here could obstruct good risk decision making. Confidence in Our Estimates We become over confident in our ability to assess the ranges of possible outcomes for events. The extreme possibilities, either risks or rewards, are likely to be understated. However there is a bias to underestimate the risk more than rewards because of our optimism bias. This confidence in our ability to estimate risk outcomes causes us to take excessive risk or pass up opportunities. Over Optimistic Excessive optimism results in our expectations exceeding those that are derived from unemotional assessment of the statistical results would justify. We believe that we can control events that are really out of our control. The majority of us believe than we are better than average driver; however the statistics demonstrates that only small percentage of us can be. We underestimate the probability of a bad outcome happening to us when we drive. The bad drivers will have accidents but it will not happen to us. What do you estimate the probability of you having an automobile accident? .100, .200, .300 or greater. The most current Department of Transportation statistics give the probably of an automobile accident as 0.671, with the probability of 0.323 for an injury accident, and a probability of 0.006 that the accident will result in a death.