The perception of and reaction to risk is often dismissed as emotional. The first thing that happens is you're afraid, and from that fear, you feel risk. So the view of risk is becoming less cognitive while emotion becomes dominant.
Emotion is about what might happen, not so much the probability. The more emotional the event is, the less sensible people are.

The perception of risk

Decision making can be divided into three systems: Emotional, rational, and perceptual systems.
The rational model is one where the beliefs and desires are supposed to be determined, but decision analysis of the last thirty years has shown that it doesn't work. Even people who are explicitly trained to used System 2 thinking (reasoning) in problems don't do so, even when they know they should.
It doesn't mean you shouldn't take decision analysis, just that decision analysis are not effective if decision-makers do not want to relinquish the intelligence function to somebody else.

Decision analysis

Decision analysis is based on the idea that decision making is a choice between gambles. Managers think that they are fighting risk in a controlled way. The idea that you are gambling is an admission that you have lost control. It is detestable to decision managers, and the reason they reject decision analysis.
It is advisable for organizations to dedicate some effort to study their own decision processes and their own mistakes, and to keep track so they can learn from those mistakes.

Why decision-makers don't like decision analysis

<ul>
<li>Groups are better equipped than individuals to recognize an answer as correct. But, when the whole group is susceptible to similar biases, groups are inferior to individuals.</li>
<li>Polarization can occur in groups. One major bias in risky decision making is optimism, while doubts are suppressed. If an individual in a group is thinking differently to the group, it is easy to understand how they would suppress themselves.</li>
<li>However, in groups of competing individuals, such as the corporate investment committee, the different dynamics can lead to better decision-making.</li>
<li>In an internal marketplace where groups come to a consensus about the risks and rewards associated with their decisions, internal incentives can shape how the group perceives risks and rewards that are different from the reality of the risks and rewards in the external marketplace. The incentives can distort risk perception.</li>
</ul>

Group decisions are not risk-free

In statistical thinking, professional statisticians informally think the degree of the probability distribution in a small group will closely resemble the probability distribution in the overall population.
In other words, even people who should know better make these mistakes. When they're not computing seriously in System 2 mode (reasoning), they rely on their intuitions for simple problems.

The law of small numbers

There are two thinking systems, each with distinct characteristics.
<ul>
<li>System 1, or intuition. We think in this way most of the time. We respond to the world in ways that we're not conscious of and don't control. System 1 operations are fast, effortless, associative, and emotionally charged. They're governed by habit, so it's more difficult to modify or control.</li>
<li>System 2, or reasoning. It is a deliberate reasoning system. It's slower, serial, effortful, and controlled.</li>
</ul>

The two-system theory

Both individuals and groups need mechanisms to review how their decisions are made.
<ul>
<li>Many businesses are averse to appointing someone to keep statistics on the decisions made and evaluate the biases, errors, the wrong forecasts, and the misjudged factors to make the process more rational.</li>
<li>Individuals do not even keep track of having made the decision or forecast. We're also unaware of changing our minds even when we do change our minds. Instead, people reconstruct their past opinion and believe they always thought that.</li>
</ul>

Mechanisms needed for individuals and groups

People are not accustomed to thinking hard. They are often satisfied with a plausible answer that comes quickly to mind.
The prospect theory - the empirical exploration of risk assessment, loss aversion, and reference dependence, explains why people consistently behave in ways that traditional economic theory could not predict.

The two-system theory

Similar ideas to The two-system theory

The Two-System Brain