Loss aversion
[4] Loss aversion was first proposed by Amos Tversky and Daniel Kahneman as an important component of prospect theory.
[5][6] In 1979, Daniel Kahneman and his associate Amos Tversky originally coined the term "loss aversion" in their initial proposal of prospect theory as an alternative descriptive model of decision making under risk.
[10] In the 2000s, behavioural finance was an area with frequent application of this theory,[11][12] including on asset prices and individual stock returns.
Methods established by Botond Kőszegi and Matthew Rabin in experimental economics illustrates the role of expectation, wherein an individual's belief about an outcome can create an instance of loss aversion, whether or not a tangible change of state has occurred.
Loss aversion coupled with myopia has been shown to explain macroeconomic phenomena, such as the equity premium puzzle.
Prospect theory and loss aversion suggests that most people would choose option B as they prefer the guaranteed $920 since there is a probability of winning $0, even though it is only 1%.
This demonstrates that people think in terms of expected utility relative to a reference point (i.e. current wealth) as opposed to absolute payoffs.
[21] Loss aversion and the endowment effect lead to a violation of the Coase theorem—that "the allocation of resources will be independent of the assignment of property rights when costless trades are possible".
The authors also ruled out the explanation that lack of experience with trading would lead to the endowment effect by conducting repeated markets.
Likewise, sellers who indicated a lower willingness-to-accept than the randomly drawn price sold the good and vice versa.
This incentive compatible value elicitation method did not eliminate the endowment effect but did rule out habitual bargaining behavior as an alternative explanation.
David Gal (2006) argued that many of the phenomena commonly attributed to loss aversion, including the status quo bias, the endowment effect, and the preference for safe over risky options, are more parsimoniously explained by psychological inertia than by a loss/gain asymmetry.
Gill and Prowse (2012) provide experimental evidence that people are loss averse around reference points given by their expectations in a competitive environment with real effort.
After several months of training, the monkeys began showing behavior considered to reflect understanding of the concept of a medium of exchange.
[45] Chen, Lakshminarayanan and Santos (2006) also conducted experiments on capuchin monkeys to determine whether behavioral biases extend across species.
[48] Subsequent research performed by Johannes Abeler, Armin Falk, Lorenz Goette, and David Huffman in conjunction with the Institute of Labor Economics used the framework of Kőszegi and Rabin to prove that people experience expectation-based loss aversion at multiple thresholds.
In this latest experiment, Fryer et al. posits framing merit pay in terms of a loss in order to be most effective.
[51] Thomas Amadio, superintendent of Chicago Heights Elementary School District 170, where the experiment was conducted, stated that "the study shows the value of merit pay as an encouragement for better teacher performance".
It has later been proven that inconsistencies may only have been due to methodological issues including the utilisation of different tasks and stimuli, coupled with ranges of potential gains or losses sampled from either payoff matrices rather than parametric designs, and most of the data are reported in groups, therefore ignoring the variability amongst individuals.
There is a significant correlation between degree of loss aversion and strength of activity in both the frontomedial cortex and the ventral striatum.
Biased anticipation of negative outcomes leading to loss aversion involves specific somatosensory and limbic structures.
fMRI test measuring neural responses in striatal, limbic and somatosensory brain regions help track individual differences in loss aversion.
Its limbic component involved the amygdala (associated with negative emotion and plays a role in the expression of fear) and putamen in the right hemisphere.
The latter cluster partially overlaps with the right hemispheric one displaying the loss-oriented bidirectional response previously described, but, unlike that region, it mostly involved the posterior insula bilaterally.
All these structures play a critical role in detecting threats and prepare the organism for appropriate action, with the connections between amygdala nuclei and the striatum controlling the avoidance of aversive events.
Hence, there is a direct link between individual differences in the structural properties of this network and the actual consequences of its associated behavioral defense responses.
Even when no choice is required, individual differences in the intrinsic responsiveness of this interoceptive system reflect the impact of anticipated negative effects on evaluative processes, leading preference for avoiding losses rather than acquiring greater but riskier gains.
[59] Individual differences in loss aversion are related to variables such as age,[60] gender, and genetic factors,[61] all of which affect thalamic norepinephrine transmission, as well as neural structure and activities.
In a study, adolescents and adults are found to be similarly loss-averse on behavioural level but they demonstrated different underlying neural responses to the process of rejecting gambles.
It is possible that adding affectively arousing factors (e.g. peer influences) may overwhelm the reward-sensitive regions of the adolescent decision making system leading to risk-seeking behaviour.
