From the Association for Pyschology Science Observer Magazine.

Hardly a minute goes by in our lives when we don’t make them. Decisions can be as small as our choices of words or what to have for lunch, and they can be as big as how to plan for retirement or what treatment to choose for a disease. They can balance certainties against risks. They can balance short-term gratification against long-term benefits. They can clearly be right or wrong — but often enough, they involve likelihoods and possibilities that are uncertain, even in the light of all available information.

Psychological scientists have been interested in how people make decisions for several decades, but philosophers and economists have been studying decision making for centuries. The most famous scholarly consideration of making a decision in cases when all the facts aren’t on hand is that of Blaise Pascal. In 1670, in his Pensées, the French philosopher articulated what was, in his time, a pretty profound dilemma for rational people: to believe or not believe in the existence of God. Pascal reasoned it out this way: If God exists, belief in Him will mean eternal salvation. If He doesn’t exist, Pascal said, one loses nothing by believing. So the choice was clear: Believing is the safest bet. And if you don’t believe, you should pretend to believe, because in so doing you might come around to genuine belief in time.

Pascal’s famous wager is the first formulation of what in the study of decisions came to be known as the theory of expected value: When faced with a choice between uncertain alternatives, you should determine the positive or negative values of every possible outcome, along with each outcome’s probability, and then you should multiply the two and choose the option that produces the highest number.

It sounds simple, but choices in the real world are seldom that cut-and-dried. Expected value was given more nuance by Daniel Bernoulli in 1738 with his theory of expected utility. Along with the values and probabilities of different uncertain outcomes, the Dutch-Swiss mathematician noted, there are two individual factors that would also be taken into account by any rational decision maker — his or her comfort with or aversion to risk, and the utility of a given payoff depending on his or her preferences or needs. Value, in other words, isn’t an absolute. For example, a small monetary gain would be of greater utility to a poor person than to a rich person, and thus their decisions in a gamble could be entirely different but equally rational.

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You might also be interested in:

• A History of Behavioural Finance in Published Research
• The Behavioural Finance Research Library