Disappointment Without Prior Expectation - Understanding Emotion in Decisions Under Risk

While profit and loss can be measured easily enough, the emotional responses that determine whether results feel like success or failure are much more complicated. INSEAD's Associate Professor of Decision Sciences, Philippe Delquié, and Alessandra Cillo argue this response is not a factor of prior expectations, as suggested by previous studies. Instead, outcomes are valued relative to all missed outcomes, whether these alternatives were foreseen or not. This paper has profound implications for behavioral finance, while offering insight into factors surrounding major investment and business decisions.

by Philippe Delquié, Alessandra CILLO

Every day, important business decisions are made by combining knowledge and logical thought with more mysterious elements such as 'gut feel', instinct and various forms of intuition. In situations where decisions must be made quickly with high financial stakes on the line, expectations about outcomes can influence everything from determining what returns on investment constitute a successful deal, to negotiations that feel disappointing even following a winning bid. Financial measures of profit and loss are objective and easily measured, but the emotional responses that determine whether these results are a success or failure are much more complicated.

Traditionally, studies evaluating disappointment in outcomes have carried an assumption that responses are based in specific prior expectations. However, INSEAD Associate Professor of Decision Sciences Philippe Delquié and Alessandra Cillo argue that feelings of disappointment and success are not fully governed by prior expectations. Instead, evaluation of outcomes and emotional responses to decisions are based on a comparison of a full range of outcomes after the event, irrespective of whether they were predicted beforehand or not.

Previous studies of decisions under risk led to models of 'disappointment theory', a concept initially pioneered by Bell (1985) with further contributions added by Loomes and Sugden in 1986. These theories examine decisions relative to expectations held at the time, attributing emotional response to a comparison between previous expectations and what ultimately occurred. A key assumption behind this theory is that individuals will (and perhaps should) anticipate these feelings beforehand, and even take them into account when evaluating risk (i.e. make choices that are less likely to lead to disappointment). These theories are intuitively appealing, in part, because they incorporate psychological factors that determine a commitment to action.

Where classic disappointment theory is limited, however, is its failure to consider a full set of outcomes. When evaluating whether someone is emotionally elated or disappointed in an outcome, it is unlikely this will occur in a vacuum. Other factors, and parallel outcomes which can also be observed, must be considered. Allowing for comparison between multiple outcomes provides a far more realistic and increasingly useful model in cases where decisions are made time and time again, or in situations involving choices between multiple opportunities, where all outcomes can be observed. For example, suppose a person invests in a stock of company A with an expectation of modest gains and doubles his investment. Here, classic disappointment theory would suggest a feeling of elation in the result. However, if the following week it becomes apparent that if the position had been held for only a few more days, the value would have tripled, it is easy to see how the lost opportunity for further profit, even if unexpected, could shape feelings about this decision.

Thus, disappointment in outcomes of risky decisions is not so much based on prior expectations that did not occur, it is instead based on comparisons with other observed results that did occur -whether predicted beforehand or not- and are recognized as more desirable. While the timing of ex post responses would not change the original decision, this shapes perception and can influence future decisions by changing the terms of which outcomes are considered successful and what results lead to feelings of failure.

These findings have strong implications for behavioral finance, as future decisions are influenced significantly by previous experience and whether past results were framed as successful or disappointing. In addition to providing insight on trading behavior and factors influencing major business decisions, these results could also be used for creating profiles for human resources assessments and evaluating client appetite for risk.


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