Worst Case Scenarios

Leonhardt shrewdly observes:

I have an essay in this weekend’s Times Magazine about one of the lessons of the BP oil spill: the difficulty that people have estimating the odds of low-probability, high-cost events.

The BP spill is a good example of when people tend to underestimate such odds. When an event is difficult to imagine, we tend to underestimate its likelihood. The manager of the oil rig in the Gulf of Mexico probably never had a rig explode on them before, which led them to assume it would not happen. They tried to save money by skipping safety procedures, and we’re all now paying the price.

But there are also times when people overestimate the chances of a low-probability event: when that event easily comes to mind, as is the case with plane crashes. One example I didn’t have room to mention in the magazine is what economists refer to as the “favorite-longshot bias.” It holds that gamblers tend to over-bet underdogs and under-bet favorites.

(Image from xkcd)