Researching Risk Preference

We have been well-warned against judging a book by its cover. Yet many business people do exactly that when speculating about foreign cultures. Relying on cultural stereotypes to make predictions about the behavior of foreign business partners is outdated and unreliable, but in the era of multinational business, it is one of the surest ways to sabotage negotiations and relationships. In recent research, Chicago associate professor of behavioral science Christopher K. Hsee and former Chicago faculty member Elke U. Weber, now at Ohio State University, present evidence that even some of our most basic stereotypes – such as generalities about Asian vs. Western cultures – are inaccurate, and that relying on these stereotypes can lead us to misjudge the decisions of foreign counterparts.

In a recent paper, Hsee and Weber examine whether American and Chinese respondents could accurately predict the “risk preferences” of their counterparts. Risk preference is defined as one's tendency to choose a risky option (such as an investment that has equal chances to yield a 20 percent return or a 0 percent return), or a safe option of an equal or lower expected value (such as an investment with a guaranteed return of 5 percent). Although researchers have compared Chinese with Americans in many decision-related topics, little is known about how Chinese differ from Americans in their risk preference or how people formulate predictions of the risk preference of foreign counterparts.

The authors chose to compare the two countries for many reasons, including the fact that on issues such as traditional values and current political systems, the U.S. and China stand on almost opposite ends of the continuum and respectively represent Western and Eastern values. Also, both countries currently wield significant impact on the world economy.

Results from the study showed that both the Americans and the Chinese predicted that the Americans would be more willing to take risks. The Americans underestimated the Chinese propensity to seek risk, and the Chinese overestimated the Americans' willingness to take risks.

Contrary to these predictions, the authors found that the American participants were considerably more risk-averse than the Chinese.

"We are talking about relative terms," says Hsee. "We do not imply that the Americans are not risk-seeking enough or the Chinese are not prudent enough. We do not draw conclusions about what is the optimal level of risk-seeking. Maybe the Chinese are too risk-seeking, or maybe the Americans are too risk-averse."

To measure the risk preference between the two cultures, Hsee and Weber provided university students from China and America with questionnaires that offered a series of choices between sure options and risky options. For example, respondents were asked to choose between receiving a fixed sum of $400 or flipping a coin and receiving either $2,000 or $0 depending on the outcome of the coin flip. In another study, respondents were asked to choose between a safe investment option (with a fixed 4 percent return) and a riskier investment option (with an uncertain return rate ranging from 0 to 8 percent). In both studies the Chinese respondents were more inclined to take the risky option than the American respondents.

To determine whether participants can accurately judge the risk preference of other cultures, respondents in the first study were also asked to predict how their counterparts from the other country would react in the outlined situations. Both Americans and Chinese participants believed the Americans would be more willing to choose the risky option. This prediction directly contradicts the actual risk preference.

To explain why the Chinese are more risk seeking than the Americans, the authors explored two possible hypotheses: the "cushion" hypothesis and the "opportunity" hypothesis. The cushion hypothesis is based on findings in the existing literature that individualistic cultures like the U.S. emphasize personal freedom and independence and collectivist societies such as China endorse social relatedness and interdependence with family and community. The cushion hypothesis is also based on an idea for which Weber has found ample empirical support, namely, that differences in risk preference can occur because individuals have different perceptions of the dangers of a risky option. In other words, depending on the country in which an individual gained his or her cultural beliefs and attitudes, this individual may perceive the same risky option to involve more (or less) risk than someone from a different culture.

"Compared with those in an individualistic society," say Hsee and Weber, "people in a collectivist society may be more likely to receive help if they are in need. As a result, the adverse outcome of a risky option may not seem as severe to them. They appear to be less risk averse. In other words, people in a collectivist culture feel that they are 'cushioned' in case they fall. That's why we call it the cushion hypothesis."

Follow-up work by Weber and Hsee has confirmed the prediction of the cushion hypothesis. The Chinese do perceive the risks involved in risky financial decisions to be less severe than their American counterparts.

The "opportunity hypothesis" is related to the current economic situations of the two countries and focuses on differences in their attitudes toward risk. "China today is very much like America during the Gold Rush period," says Hsee. "The economy is developing rapidly, and many people benefit from taking great risks. This is less true for people in countries with well-developed economies such as the U.S. Americans today may not find it beneficial to take unnecessary risks."

Then why do both the Americans and the Chinese make wrong predictions about the risk preference of their counterparts in the other country? The authors suggest that people often base their predictions on stereotypes. Ubiquitous mass media images which influence our view of cultures tend to promote the stereotype of the risk-seeking, independent American. (Never mind that many Chinese enjoy gambling today). Popular Chinese stereotypes reflect more cautious, conservative and collectivist characteristics, even when they originate in Chinese-made productions.

The cultural stereotype about Chinese risk aversion may have been correct at some point, suggest Hsee and Weber, but it lags behind current social and economic activities that are reshaping the country and its identity. The same may be true of the American risk-seeking stereotype. The authors cite research that highlights changes in the American social and political landscape since the 1960s that may have affected American attitudes toward risk in the direction of less public trust and greater individual caution.

Hsee and Weber found that when respondents tried to factor in cultural differences when predicting the risk preference of people in another country, they did so incorrectly, and therefore, they were not able to make accurate cross-cultural predictions of risk preference.

As the authors continue to research the modern risk preferences of other cultures such as Germany and Poland, their current findings encourage us to examine general cultural stereotypes. International business people should ask themselves: Are there differences in my attitudes toward risk compared with the attitudes of my foreign partners? Can I accurately predict their decisions?

"In business negotiations between parties from different cultures with different risk preferences, there is greater potential for an integrative bargaining solution if these parties have accurate beliefs about the other party's risk preference," says Hsee.

He adds that accurate predictions of other people's risk preference is also very important in constructing foreign policy. "To some extent," says Hsee, "the recent crisis with Saddam Hussain involved accurately predicting Hussain's tendency to take or to avoid risk. How much risk will he take? What is his level of risk preference in regards to armed warfare?"