PROSPECT THEORY AND POLITICAL SCIENCE Jonathan Mercer

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actors should behave if everyone adheres to normative decision theory. Behavioral
theories help by explaining how people tend to reason.
Policy Implications of Loss Aversion
The policy implications of loss aversion come in two stripes: Beware loss aversion
in your own policies, and anticipate loss aversion in the policies of others. The
first is harder to implement than the second. It is not always clear what we can
do to avoid psychological biases. Behavioral finance has become popular in part
because it not only tells us what we do wrong—we tend to sell winning stocks
too soon and hold on to losing stocks too long (Odean 1998)—but also tells us
what we can do differently (buy index funds!). Awareness of biases is not always
sufficient to change behavior. However, knowing how other people reason may
help in designing policy toward others.
In strategic settings, where my best move depends on your move, knowing what
you are likely to do is more helpful than knowing what you should do. For example,
although defection is the rational choice in the game of Prisoner’s Dilemma,
30 years of experimentation on this and strategically equivalent games (such as
commons dilemmas) has invariably found what one researcher calls “rampant cooperation”
(Colman 2003, p. 147). In a variety of games of strategic choice—such
as Matching, Centipede, and Ultimatum games—the rational choice is typically
the worst choice because people do not do what they are “supposed” to do (Colman
2003). If people think differently than they are supposed to, then knowing how
they are supposed to think is not helpful and can be a source of mistakes (Mercer
2005). Better understanding when people will, for example, behave in a risk-averse
or risk-acceptant way should help us in our strategic interactions.
For example, loss aversion may be key to understanding when a threat or a
promise works best. Davis (2000) draws on prospect theory to provide an elegant
answer to an important puzzle: When will threats deter but not cause unwanted
escalation, and when will promises deter but not cause increased demands? Threats
increase the risks and costs to a challenger, and promises decrease the risks and
costs to a challenger. Davis combines earlier, empirically driven work on deterrence
failure (e.g., Lebow & Stein 1987) with prospect theory to argue that threats should
be most effective against actors who seek gains and least effective against actors
who seek to avoid losses. Promises should be most effective against actors who
seek to avoid losses and least effective against actors who seek gains. Davis wrings
from prospect theory not only when which type of influence attempt is best, but
also what type of threat or promise is likely to be most effective. For example, a
promise that reduces or eliminates a target’s losses should be more effective than
one that augments some other value (Davis 2000, p. 37). Davis provides no insight,
independent of detailed historical analysis, on how we can determine an actor’s
motivation. Instead, he notes that prospect theory leads us to expect fear of loss,
more than hope for gain, as a dominant motive for aggression. If this expectation is
correct—and his empirical chapters suggest that it is—then deterrence theorists’
emphasis on threats is likely to cause conflict, not deter it.