Asymmetric detection of changes in volatility: Implications for risk perception

Abstract

Variance of the outcomes associated with an option often provides a measure of the riskiness of that option. Hence, it is important that organisms are able to detect any sudden changes in outcome variance. In Experiment 1, we presented people with graphs of share price time series or water level time series. In half the graphs, variance (financial or flooding risk) changed at some point. People were better at detecting increases than decreases in risk - maybe because it is more important to detect increases in danger than decreases in it. However, in Experiment 2, people were still better at detecting increases than decreases in variance even when those changes did not reflect altered levels of risk. Our findings may reflect the fact that the actual change in variance exceeds the change needed to identify a regime change in variance by a larger amount for upward than for downward changes.


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