Decision structure of risky choice

TL;DR

This paper proposes a unified theory of risky choice that explains decision-making processes, preference reversals, and anomalies by considering decision structure simplification based on cognition and strategy adaptation.

Contribution

It introduces a novel framework that unifies compensatory and non-compensatory theories through decision structure simplification influenced by cognitive limitations.

Findings

Decision making involves simplifying complex decision structures.

Preference reversals result from different paths in decision structure simplification.

Decision strategies depend on the situation and cognitive constraints.

Abstract

As we know, there is a controversy about the decision making under risk between economists and psychologists. We discuss to build a unified theory of risky choice, which would explain both of compensatory and non-compensatory theories. For risky choice, according to cognition ability, we argue that people could not build a continuous and accurate subjective probability world, but several order concepts, such as small, middle and large probability. People make decisions based on information, experience, imagination and other things. All of these things are so huge that people have to prepare some strategies. That is, people have different strategies when facing to different situations. The distributions of these things have different decision structures. More precisely, decision making is a process of simplifying the decision structure. However, the process of decision structure simplifying is not stuck in a rut, but through different path when facing problems repeatedly. It is why preference reversal always happens when making decisions. The most efficient way to simplify the decision structure is calculating expected value or making decisions based on one or two dimensions. We also argue that the deliberation time at least has four parts, which are consist of substitution time, first order time, second order time and calculation time. Decision structure also can simply explain the phenomenon of paradoxes and anomalies. JEL Codes: C10, D03, D81