Perception of probabilities in situations of risk: A case based approach

This paper provides a description of a possible mental process individuals go through in their attempt to comprehend stated probabilities in simple lotteries. The evaluation of probabilities is based on the following main components: lotteries encountered in the past, the realizations of these lotteries, and the similarity between stated probabilities. A probability is evaluated based on the experienced relative frequencies of outcomes that had that stated probability, as well as outcomes of other lotteries that had similar stated probabilities. This process may result in distortion of probabilities as observed in the literature, and in particular, in overvaluing low probabilities and undervaluing high probabilities. If the decision maker uses a less permissive similarity function as the size of memory grows, she will learn the real value of the stated probabilities. If, however, the similarity function is independent of memory, biases persist even when data are accumulated.