Uncertainty effect

The uncertainty effect, also known as direct risk aversion, is a phenomenon from economics and psychology which suggests that individuals may be prone to expressing such an extreme distaste for risk that they ascribe a lower value to a risky prospect (e.g., a lottery for which outcomes and their corresponding probabilities are known) than its worst possible realization.^[1][2]

For example, in the original work on the uncertainty effect by Uri Gneezy, John A. List, and George Wu (2006), individuals were willing to pay $38 for a $50 gift card, but were only willing to pay $28 for a lottery ticket that would yield a $50 or $100 gift card with equal probability.^[1]

This effect is considered to be a violation of "internality" (i.e., the proposition that the value of a risky prospect must lie somewhere between the value of that prospect’s best and worst possible realizations) which is central to prospect theory, expected utility theory, and other models of risky choice.^[1] Additionally, it has been proposed as an explanation for a host of naturalistic behaviors which cannot be explained by dominant models of risky choice, such as the popularity of insurance/extended warranties for consumer products.^[2]