principleadvancedabstract

Probability Weighting

People overweight small probabilities and underweight moderate to high probabilities, with certainty being overvalued relative to near-certainty.

In Depth

Part of prospect theory: people don't weight probabilities linearly. A 1% chance feels much more significant than 1% of the value, explaining lottery ticket purchases and terrorism fears. A 99% chance feels less secure than certainty, explaining why people pay premiums to eliminate risk entirely (the certainty effect). Moderate probabilities (30-70%) are underweighted. This pattern explains why people simultaneously buy insurance (overweighting small probability of large loss) and lottery tickets (overweighting small probability of large gain).

Example

People pay $5 for a lottery ticket with a 1-in-10-million chance of winning $10 million (expected value: $1), overweighting the tiny probability. They also pay $100 to increase insurance coverage from 99% to 100%, overvaluing certainty.

Common Misconception

People weight probabilities proportionally to their numerical values—small probabilities are overweighted and certainty is overvalued relative to near-certainty.

Source

Thinking, Fast and Slow

Daniel Kahneman

behavioral economicsprobabilitydecision theory

Related Concepts

builds on

Prospect Theory

People evaluate outcomes relative to a reference point rather than in absolute terms, are loss-averse, show diminishing sensitivity, and overweight small probabilities.

builds on

Prospect Theory

People evaluate outcomes relative to a reference point rather than in absolute terms, are loss-averse, show diminishing sensitivity, and overweight small probabilities.

Test Your Understanding

active recallmedium

How does probability weighting explain why people pay premiums to increase insurance coverage from 99% to 100%?

concept connectionhard

How does probability weighting relate to the availability heuristic?