IQ and Risk-taking

A recent study by Shane Frederick at MIT, published in the Journal of Economic Perspectives [pdf], has gotten press attention in the last few weeks for its claim that performance on a simple math test predicted risk-taking behavior. I'm a bit skeptical about the conclusions Frederick's draws (and I'll explain why), but regardless, the study itself is quite interesting.

The study begins by asking subjects to take the Cognitive Reflection Test (CRT), which consists of three simple math questions:

1. A bat and a ball cost $1.10 in total. The bat costs $1.00 more than the ball. How much does the ball cost?
2. If it takes 5 machines 5 minutes to make 5 widgets, how long does it take 100 machines to make 100 widgets?
3. In a lake, there is a patch of lily pads. Every day the patch doubles in size. If it takes 48 days for the patch to cover the entire lake, how long would it take for the patch to cover half the lake?

Then subjects are asked two other types of questions:

(a) Would you rather have $3400 now or $3800 in two weeks?
(b) Would you rather have a guaranteed $1000, or a 90% chance of $5000?

Questions of type (a) provide some measure of your "time preference" - how patient you are when it comes to money matters - while questions of type (b) provide a measure of your degree of risk-taking; people who prefer the more certain but lower-expected-value item are more risk-averse than those who choose the opposite. Interestingly, Frederick found that subjects who scored well on the CRT also tended to be more "patient" on questions like (a) and more risk-taking on questions like (b). Much of the discussion in the paper is centered around why and to what extent cognitive abilities, as measured by the CRT, would have an impact on these two things.

It's fascinating work, except it seems to me that there's an alternative explanation for these results that has little to do with cognitive abilities. One strand of such an explanation (which Frederick mentions himself) is that, in addition to mathematical skills, the test measures the ability to overcome impulsive answers. Each of the questions has an "obvious" answer (10 cents, 100 minutes, 24 days) that is incorrect; high-scorers thus need to be able to inhibit the wrong answer as well as calculate the correct one; they tend to be more patient and methodical as well as better at math. It's easy to see how these abilities, not cognitive ability per se, might account for the differential performance on questions like (a).

The deeper problem is that the study failed to control for socioeconomic differences between subjects. The high-performing subjects were taken from universities like Harvard, MIT, and Princeton; the lower-performing subjects were taken from universities like University of Michigan and Bowling Green. People at the latter universities are likely to be in a far more precarious financial situation than those at the former. Why does this matter? One of the principle findings of Kahneman & Tversky's prospect theory is that as you have less money, you become more risk averse. Thus it seems entirely possible to me that the difference between subjects was because of differences in their financial situation, and had nothing to do with cognitive abilities at all (except possibly indirectly, as mediated through socioeconomic factors). I'd be interested in seeing if this finding still holds up even when SES is controlled for.

Posted by Amy Perfors at February 21, 2006 6:00 AM