Does Everyone Use Probabilities? Intuitive and Rational Decisions about Stockholding

Johannes Binswanger and Martin Salm

No 7265, IZA Discussion Papers from IZA Network @ LISER

Abstract: We investigate the relationship between subjective probabilities of future stock market returns and decisions about stockholding. Specifically, we examine whether acting upon subjective probabilities is confined to individuals with high cognitive skills. We explore this question using data from the U.S. Health and Retirement Study (HRS). Our empirical analysis is guided by a novel and simple model based on the dual-systems framework from psychology (Kahneman, 2003). In our model, individuals with low cognitive skills make decisions in an intuitive non-probabilistic way based on cues and feelings. Individuals with high cognitive skills make decisions akin to the expected utility model. As predicted by our model, in our empirical analysis we find that there is a significantly stronger association between subjective return probabilities and stockholding decisions for individuals with high cognitive skills, compared to individuals with lower cognitive skills. The paper contributes to a better understanding of the role of cognitive skills in decision making under uncertainty.

Keywords: subjective expectations; probabilities; dual system decision making; cognitive skills; cognitive economics (search for similar items in EconPapers)
JEL-codes: D03 D81 D84 G11 (search for similar items in EconPapers)
Pages: 45 pages
Date: 2013-03
New Economics Papers: this item is included in nep-cbe and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

Published - revised version published as 'Does everyone use probabilities? The role of cognitive skills' in: European Economic Review, 2017, 98, 73-85

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