DIW Applied Micro Seminar

Is using probabilities in decision making under uncertainty a universal pattern? Or is it confined to individuals with high cognitive skills? We address this question based on a novel theoretical approach and on data on subjective probabilities from the Health and Retirement Study (HRS). Our analysis focusses on stockholding decisions. Our theoretical model relies on the dual-systems framework from psychology. Individuals with low cognitive skills make decisions in an intuitive nonprobabilistic way based on cues and feelings. Individuals with high cognitive skills make decisions akin to the expected utility model. In our empirical analysis, we find substantial evidence that the association between subjective probabilities and behavior is much stronger for individuals with high cognitive skills than for those with low cognitive skills. Our findings suggest that decision making akin to the expected utility model may indeed be confined to individuals with higher cognitive skills.