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Cognition and Wealth: The Importance of Probabilistic Thinking


Lee A. Lillard (deceased)


Deceased

Robert J. Willis


University of Michigan at Ann Arbor - Department of Economics; National Bureau of Economic Research (NBER)

June 1, 2001

Michigan Retirement Research Center Research Paper No. WP 2001-007

Abstract:     
This paper utilizes a large set of subjective probability questions from the Health and Retirement Survey to construct an index measuring the precision of probabilistic beliefs (PPB) and relates this index to household choices about the riskiness of their portfolios and the rate of growth of their net worth. A theory of uncertainty aversion based on repeated sampling is proposed that resolves the Ellsberg Paradox within a conventional expected utility model. In this theory, uncertainty aversion is implied by risk aversion. This theory is then used to propose a link between an individual's degree of uncertainty and his propensity to give "focal" answers of "0", "50_50" or "100" or "exact" answers to survey questions and the validity of this interpretation is tested empirically. Finally, an index of the precision of probabilistic thinking is constructed by calculating the fraction of probability questions to which each HRS respondent gives a non-focal answer. This index is shown to have a statistically and economically significant positive effect on the fraction of risky assets in household portfolios and on the rate of growth of these assets longitudinally. These results suggest that there is systematic variation in the competence of individuals to manage investment accounts that should be considered in designing policies to create individual retirement accounts in the Social Security system.

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Date posted: January 17, 2008  

Suggested Citation

Lillard (deceased), Lee A. and Willis, Robert J., Cognition and Wealth: The Importance of Probabilistic Thinking (June 1, 2001). Michigan Retirement Research Center Research Paper No. WP 2001-007. Available at SSRN: http://ssrn.com/abstract=1084559 or http://dx.doi.org/10.2139/ssrn.1084559

Contact Information

Lee A. Lillard (deceased)
Deceased
N/A
Robert J. Willis (Contact Author)
University of Michigan at Ann Arbor - Department of Economics ( email )
611 Tappan Street
Ann Arbor, MI 48109-1220
United States
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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