Heterogeneous Risks and the Intangibility of Risk Reduction: Theory and Experimental Evidence

with Todd Cherry and George Loewenstein

Work in Progress

In this paper, we examine how the observability of disaster sources influences an individual’s willingness to invest in mitigating an endogenous risk. We begin by developing a theoretical model in which an agent invests to reduce an endogenous risk. Feedback about the source of realized losses shifts beliefs about investment efficacy. We then test hypotheses derived from the model in a 2$\times$2 laboratory experiment that varies the level of exogenous risk exposure (high or low) and the tangibility of the outcome (observable or unobservable source feedback). From this experiment, we find three main results. We find that intangible outcomes systematically reduce investment in risk reduction following a disaster, but this effect is stronger and more consistent among participants with low exogenous risk exposure than among those with high risk exposure. A secondary finding suggests that intangible non-events, in which participants cannot observe whether their investment prevented a disaster, increase subsequent investment, consistent with defensive overinvestment under uncertainty. This evidence highlights that policymakers should adapt institutions to reward policies with invisible outcomes.