Uncertainty is inherent in every walk of life and decisions made in the face of such uncertainties reflect the underlying risk preferences of the decision maker. Important economic decisions such as investment and consumption are based on the risk-preferences of individuals. However, often, little thought is given to understand the mechanisms underlying and the factors influencing risk preferences. We contemplate on the role that belief systems play in shaping risk preferences.
We restrict the definition of a belief system to a set of behavior governing norms. These norms may be derivatives of a religion or school of thought. We do not intend to delve into the complexity of belief systems; hence we assume that there exist two belief systems in the world that are mutually exclusive and exhaustive in the universe of belief systems. This is a highly simplifying assumption, but sufficient for expositional purposes. We also assume that people have preferences over the choice of their belief systems expressed by a probability distribution, determined by a well-defined set of factors that include social norms and perception of utility from adhering to a given belief system. This means that interpretation of the same belief system can vary across individuals. These preferences are dynamic, that is they change over time. We postulate that the degree of risk aversion, as reflected in actions observed, are derived from the belief system an individual adheres to. Specifically, a more risk-averse individual will belong to a particular belief system, reasons for which are discussed below.
Suppose there are two belief systems: B1 and B2. The belief space in each system is divided into two subsets consisting of core and non-core beliefs. Let X1 and Y1 be the subsets of core and non-core beliefs in B1 and X2 and Y2 the subsets of core and non-core beliefs in B2. Also, X1 > X2 , and Y1 < Y2 i.e. the number of core beliefs is higher in the B1 and number of non-core beliefs is higher in B2. The core beliefs, we argue, are hard to alter. Non-core beliefs, on the other hand, are likely to change over time and can be seen as Bayesian in nature i.e. the beliefs are updated upon the receipt of more information. A good example of core beliefs is the 17th century Catholic view of the cosmos, which despite the empirically proven heliocentric view put forth by Galileo, remained unaltered for years. Contrarily, consider the case of weather forecasting. Scientific advances made over time provide a farmer with greater reasons to believe his mobile phone over Zeus. This forms a non-core belief.
We propose that the specific elements in the core set can determine the risk preferences to a large extent. If we assume that the number of core elements is positively correlated to higher risk aversion, then people adhering to B1 are likely to be more risk averse than people adhering to B2. These preferences can be reflected in realm of financial decisions, economic decisions as well as personal decisions. Further, the elements in the form of proscriptions can also explain instances of irrational behavior in the sense of economic theory. This includes cooperative behavior, altruism and trust. This has been verified by several existing studies. Anderson and Mellor (2009) find that religion may sustain cooperation. Through a repeated public goods game, they show that decline in public goods contribution by religious participants tends to decline less relative to non-religious participants. They suggest this observation may be due to religious instructions that promote altruism.
Coming to our proposition, it is more of a shot in the dark than an empirically verified one. Nonetheless, we believe it�s one to ponder upon and testable using experimental methods.
—Bhavook Bhardwaj and Suvi Agrawal
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References
Anderson, L.R. and Mellor, J.M., 2009. Religion and cooperation in a public goods experiment. Economics Letters, 105(1), pp.58-60.
