Loss aversion

Loss aversion ( loss aversion , English : loss aversion ) referred to in the psychology and economics tend losses greater weight than profits . For example, you are annoyed more about the loss of € 100 than you are happy about the profit of € 100.

Loss aversion is part of the Prospect Theory ( German : New Expectation Theory ), which was established by Kahneman and Tversky in 1979 .

An important finding of this theory is that individuals behave irrationally in decision-making situations when uncertainties play a role. This violates the assumption of neoclassical economic decision theory, according to which the homo economicus acts in a utility-maximizing and rational manner.

model

Hypothetical value function

Loss aversion is based on a hypothetical value function ( English : value function ) models. Kahneman and Tversky describe the value function as follows:

${\ displaystyle V (x) = {\ begin {cases} x ^ {\ alpha}, & {\ text {if}} x \ geq 0 \\ - \ lambda (-x) ^ {\ alpha}, & { \ text {if}} x <0 \ end {cases}}}$

The parameter λ> 1 says that the person is loss-averse. The coefficient α <1 reflects the decreasing sensitivity . In their test series, Kahneman and Tversky determined average values λ = 2.25 and α = 0.88.

The function has a reference point that is used to code an event as profit or loss. Here the change starting from the reference point is decisive. The reference point represents either an actual state ( status quo ) or a target state ( aspiration level ). Each person selects their reference point individually.

For example, a person can set out to achieve a certain amount x (target state as a reference point). If the amount actually achieved is below the reference point, this difference is perceived as a loss; an amount greater than the reference point is coded as a profit.

The function has a turning point at the reference point . The curve is concave for gains and convex for losses. Individuals are in the range of possible profits risk averse and possible losses in the field risikoaffin . The curvature is the principle of decreasing sensitivity (English diminishing sensitivity ) from. Since the value function is steeper in the loss area than in the profit area, one can see that losses are weighted more heavily than gains.

This means that the difference in value between profits of 100 and 200 is perceived as subjectively greater than between 1000 and 1100. The same applies to the loss range.

Experiments

Lotteries

The extent of loss aversion was measured by Kahneman through several experiments. Individuals were asked what would be the lowest profit they would need to make up a 50 percent chance of losing $ 100. The most common answer was $ 200, double the possible loss or four times the statistically probable loss. The loss aversion rate averaged between 1.5 and 2.5 in several experiments.

Kahneman observed that people were extremely risk averse in mixed lotteries, where both a win and a loss can be realized.

taxi driver

Colin F. Camerer , an American economist and professor of economics at the California Institute of Technology , provided further evidence of Kahneman's and Tversky's theory of loss aversion in the 1990s . He observed the behavior of New York taxi drivers and found that they had flexible wages and thus a daily fluctuating income. According to the assumption of a utility-maximizing individual, drivers would have to work long hours on days when there is high demand in order to compensate for the days with low demand. Camerer, however, observed a different, irrational behavior. The taxi drivers set themselves a daily sales target that they wanted to achieve regardless of demand. On days when there was little demand, the drivers worked much longer to reach this figure.

findings

Loss aversion can explain many different phenomena.

One of the best-known examples is the “ possession effect ” ( Richard Thaler 1980). According to the possession effect, individuals attribute greater value to goods they possess than goods they do not possess. This does not correspond to the usual basic assumption of Homo oeconomicus . Kahneman , Kentsch and Thaler carried out an experiment with cups in 1990. This experiment was later repeated with other goods. Compared to the reference point, the seller regards the dispensing of the cup as a loss. Therefore, on average, the price for the good is twice as high. The buyer, on the other hand, sees the purchase of the cup as a profit and therefore has a lower reservation price .

In the Prospect Theory, Kahneman and Tversky assumed that loss aversion is a cause of “ sunk cost fallacy” (fallacy of sunk costs). When choosing their future decision alternative, individuals consider not only future costs, but also costs already incurred, which can no longer be influenced. This is a contradiction to the rational utility maximizer of neoclassical theory.

Furthermore, the theory of loss aversion provided fundamental approaches to explaining the “ equity premium puzzle ” (Rajinish Mehra & Edward C. Prescott 1985) and the “ tendency towards the status quo ” (William Samuelson & Richard Zeckhauser 1988).

The study “Individual-level loss aversion in riskless and risky choices” ( Simon Gächter , Eric J. Johnson and Andreas Herrmann, 2010) provided further insights . In the study, they found that there was no significant difference in loss aversion between men and women. The study also shows that loss aversion increases with age and that individuals become more risk averse with increasing educational level.

Practical examples

Vacation entitlement

In Germany, the statutory vacation entitlement is 24 days in accordance with Section 3 (1) of the Federal Vacation Act for every employee, compared to only 14 days in America. Most Germans would not be willing to forego their statutory vacation entitlement if they received a higher wage in return. Americans, on the other hand, are unwilling to earn less money in order to get more vacation days. For many Germans, the number of statutory vacation days is the “ status quo ” , so giving up vacation days is seen as a loss. For Americans, the number of statutory vacation days is also the “status quo” . More vacation would be profitable for Americans.

shares

In stock trading , the loss aversion is one of the most important behaviors of investors . This occurs, for example, when investors fail to sell securities that are in the red in a timely manner. You hold the stock in the hope that it will recover. Loss aversion means that investors have a greater tendency to invest in safe assets. They shy away from long, profitable investments .

Web links

http://www.decisions.ch/dissertation/diss_prospect_theory.html (June 16, 2015)
http://infoboard.zertifikatereport.de/infoboard-upload/42f64ebbca2c96be7ea7c366e1791c94.pdf (June 19, 2015)

Individual evidence

^ Daniel Kahneman, Amos Tversky: Prospect Theory: An Analysis of Decision under Risk . In: Econometrica . tape 47 , 1979, pp. 263-292 (English).

^ Richard H. Thaler, Amos Tversky, Daniel Kahneman, Alan Schwartz: The Effect of Myopia and Loss Aversion on Risk Taking: An Experimental Test . In: The Quarterly Journal of Economics . tape 112 , no. May 2 , 1997, JSTOR : 2951249 (English).

↑ Lee Davidson: When Losses Pain More Than Gains Pleasure. Morningstar, Jan 27, 2012.

^ Colin F. Camerer: Taxi Drivers and Beauty Contests. Engineering & Science No. 1, 1997.

↑ William Samuelson, Richard Zeckhauser: status quo bias in decision making. Journal of Risk and Uncertainty, 1988.

↑ Simon Gächter, Eric J. Johnson, Andreas Herrmann: Individual-level loss aversion in riskless and risky choices. Discussion Paper, 2010.

[1] Daniel Kahneman, Amos Tversky: Prospect Theory: An Analysis of Decision under Risk . In: Econometrica . tape 47 , 1979, pp. 263-292 (English).