The Psychology of Decision-Making: Risk Aversion, Cognitive Biases, and Economic Behavior

Abstract

Decision-making is a central theme in psychology and economics, reflecting the complex interplay of rational evaluation, emotional processing, and cognitive biases. This study investigates how risk aversion and cognitive biases shape economic behavior, particularly under uncertainty. Using a mixed-method approach that combines experimental behavioral tasks with econometric modeling, data were collected from 450 participants in urban South Asia. The results demonstrate that individuals exhibit strong risk aversion, often preferring certain but smaller gains over uncertain higher returns. Additionally, cognitive biases—including loss aversion, overconfidence, and framing effects—were found to significantly influence decisions in ways that deviate from standard rational choice models. Regression analysis revealed that risk aversion was positively correlated with conservative financial behavior, while overconfidence and optimism bias predicted higher engagement in speculative investments. Furthermore, gender and age moderated the influence of cognitive biases, with younger individuals and males displaying higher susceptibility to overconfidence effects. The findings highlight the inadequacy of purely rational economic models and underscore the need for policies that incorporate psychological insights into financial literacy programs, consumer protection, and behavioral nudges. By integrating psychological theories with economic analysis, this study provides valuable evidence on how cognitive processes shape real-world economic behavior, offering both theoretical and policy-level contributions to behavioral economics.