Against the Gods: The Remarkable Story of Risk
A. The History of Risk
In ancient times, the destiny of man was controlled by the whims of heavenly forces in which all events are believed to be the actions done by God. In modern times, man’s thinking has changed in which logic triumphed over experimentation and the usage of letters and numbers to make calculations. Men have accepted the notion that they are independent and active agents who have the ability to manage risks. In the Middle Ages, man invented new calculation and mental methods in which the laws of chance were developed using accounting, algebra, and the Hindu-Arabic numbering system. Scholars like Blaise Pascal, Pierre de Fermat, and Daniel Bernoulli made several contributions to the probability theory, which further investigated and analyzed the roles of risk and rational behavior, which played in our choices.
B. The Rational Behavior in making decisions
Individual decision-making shapes the foundation of macroeconomic analysis. The complication of rational behavior is optimizing a real-valued utility function. Rational Behavior is based on the Rational Choice theory that is “an economic principle that assumes that individuals always make prudent and logical decisions that provide them with the greatest benefit or satisfaction and that are in their highest self-interest.” (Investopedia) This theory is based on the assumption that the behaviors of all people are rational therefore they must be aware of its roles and limits. “The strength of the rational choice model derives from the assumption that preferences are relatively stable and not too situation-dependent.” (Levin and Milgrom, 2004) However, its main criticism is that in the real world choices highly depends on the situation and the context. Many factors like the decision maker’s emotional state, the social context of the situation, other unrelated items to the set of choices, and environmental factors leverage the choice behavior....