Ignorance illusion in decisions under risk: The impact of perceived expertise on probability weighting

Although risky decisions are affected by perceived expertise regarding the source of risk, current decision-making models assume that an individual’s attitude towards risk does not vary across different sources. A decision maker’s processing of known probabilities and the resulting degree of probability weighting should therefore be unique. This paper provides evidence that challenges this assumption. We conduct an experiment involving different gambles, i.e., risky games where objective probabilities are known, no further information-based advantages exist, and outcomes are independent of knowledge. Even though all probabilities are explicitly provided, we find that individuals engage in less severe probability weighting if they perceive their level of expertise regarding a gamble to be higher. This result suggests that individuals are subject to knowledge illusion in decisions under risk, constituting source-dependent risk attitudes. We furthermore document that knowledge illusion typically increases the attractiveness of risky prospects, yielding new insights into puzzling investor behavior observed in equity markets. Managerial and policy implications are discussed.