Behavioural Issues with Probability

René Doff

In Chapter 2, we defined risk as “the effect of uncertainty on objectives”. Often, these uncertainties can be expressed in probabilities. After the human biases we discussed in the previous chapter, the current chapter will explore biases that relate to how human beings deal with the concept of probability and statistics. Despite our time spent in statistics class, human beings have great difficulty managing concepts of chance and probability. In descriptive statistics, we often confuse the mean or average with the dispersion around the mean. For instance, if a river is on average 1.5 meters deep, would it be wise to cross it without knowing how to swim? This would be especially unwise if the middle of the river is deep because it is meant for larger cargo boats.

Many risk managers in the second line of defence (see Chapter 13) deal with statistical concepts in which probability takes a central place. As with other economic topics, human beings are biased when it comes to dealing with probabilities and statistical concepts. This is not just because some of the topics are difficult to explain, as we will see in this chapter.

Figure 7.1 provides an overview of the behavioural