Varieties of Loss Aversion

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Varieties of Loss Aversion

• Lyle Brenner
• University of Florida

Collaborators Baler Bilgin Yuval
Rottenstreich Sanjay Sood
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What is Loss Aversion?

• Initially, a component of the prospect theory
  value function

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Loss Aversion in Risky Choice

• Loss aversion explains why the following gambles
  are generally unattractive
• 50 chance to win X and 50 chance to lose X
• w(.5) v(X) w(.5) v(-X) lt 0
• or
• v(-X) gt v(X)
• Losing X is more unpleasant that getting X is
  pleasant
• Losses loom larger than gains
• Loss sensitivity rather than loss aversion?

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Applications (Myopic) Loss Aversion

• Can explain excessively timid choices in
  individual gambles, when a collection of repeated
  gambles would seem attractive (Kahneman
  Lovallo, 1994)
• Can explain why stocks are historically
  undervalued relative to bonds (Benartzi Thaler,
  1995)

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Loss Aversion in Riskless ChoiceEndowment Effect

• Loss aversion principle generalizes beyond realm
  of gambles
• Mug experiment (Kahneman, Knetsch Thaler, 1992)
• Sellers Mug worth 7.12 to those endowed with
  mug
• Buyers Mug worth 2.87 to those not endowed with
  mug
• Choosers indifferent between mug and 3.12
• Conclusion v(lose mug) gt v(get mug)

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Competing intuitions on staying vs. switching

• Endowment effect (EE) tendency to stay with what
  youve got overly value your possessions
• Grass is greener (GG) tendency to switch to
  something else overly value what you dont have

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How to define losses and gains?

• How to interpret Losses loom larger than gains?
• Ambiguity in definition of losses and gains

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Defining loss and gain in terms of valence

• Valence Loss Something bad happens
• Valence Gain Something good happens

• Valence Loss Aversion (VLA)
• Valence losses loom larger than valence gains
• unpleasant changes are more extreme than
  equivalent pleasant changes

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Defining loss and gain in terms of possession

• Possession Loss Something leaves your possession
• Possession Gain Something comes into your
  possession

• Possession Loss Aversion (PLA)
• Possession losses loom larger than possession
  gains

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Endowment Effect PLA, VLA, or both

• Why is giving up a mug worse than getting a mug
  is pleasurable?
• VLA giving up mug is a big deal because its
  negative (rather than positive)
• PLA giving up mug is a big deal because it
  involves giving up (rather than receiving)

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Relationship between Valence and Possession
Changes
Possession Change Possession Change
Possession Gain Possession Loss
Valence Change Valence Gain
Valence Change Valence Loss
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Relationship between Valence and Possession
Changes Goods
Possession Change Possession Change
Possession Gain Possession Loss
Valence Change Valence Gain
Valence Change Valence Loss
Receive Mug
Give up Mug
With Goods, possession gain/loss and valence
gain/loss are confounded (positively)
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Relationship between Valence and Possession
Changes Bads
Possession Change Possession Change
Possession Gain Possession Loss
Valence Change Valence Gain
Valence Change Valence Loss
Give up nausea
Receive nausea
With Bads, possession gain/loss and valence
gain/loss are confounded (negatively)
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Stay or Switch Predictions Goods

• Goods Have X, can switch to Y
• VLA ? stay with X
• (because negatives of giving up X loom larger
  than positives of getting Y)
• PLA ? stay with X
• (because giving up X looms larger than getting
  Y)
• Both VLA and PLA predict a tendency to stay ?
  endowment effect

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Stay or Switch Predictions Bads

• Bads Have -X, can switch to -Y
• VLA ? stay with -X
• (because negatives of getting -Y loom larger than
  positives of giving up -X)
• PLA ? switch to -Y
• (because giving up -X looms larger than getting
  -Y)
• VLA predicts staying ? endowment effect
• PLA predicts switching ? grass is greener effect
• Or if both VLA and PLA occur, then they push in
  opposite directions

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Problem 1B

• Imagine that while driving to school one day,
  youre caught going 45 mph in a 30 mph zone and
  given a speeding ticket. The penalty for the
  ticket is a fine of 100.
• A few days later, you receive a letter offering
  you the option of switching penalties. In
  particular, you may attend 3 three-hour sessions
  of traffic school instead of paying the fine of
  100.
• Choice Stay with fine, or switch to traffic
  school?

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Problems 1G and 1B Results

• Goods, Radio station call-in prize 100, or free
  Jetski rental
• Cash default 83 stay
• Jetski default 30 stay
• STAYSUM 113 gt 100 (endowment effect)
• Bads, Speeding penalties 100 fine, or traffic
  school
• Fine default 12 stay
• Traffic school default 70 stay
• STAYSUM 82 lt 100 (grass is greener effect)

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Problems 2G and 2B Results

• Goods, Jobs More money, or more vacation days
• default 59 stay
• Vacation Days default 65 stay
• STAYSUM 124 gt 100 (endowment effect)
• Bads, Jobs Long commute, or work weekends
• Commute default 52 stay
• Work weekends default 24 stay
• STAYSUM 76 lt 100 (grass is greener effect)

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Problems 3G and 3B Results

• Goods, Apartments Spacious, or great location
• Spacious default 71 stay
• Location default 44 stay
• STAYSUM 115 gt 100 (endowment effect)
• Bads, Apartments Noisy, or cramped
• Noisy default 66 stay
• Cramped default 39 stay
• STAYSUM 105 100 (no effect)

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GG- EE-
EE, GG-, EE gt GG-
EE, GG-, GG- gt EE
2
1
3
EE, EE-, EE gt EE-
GG, GG-, GG- gt GG
EE, EE-, EE- gt EE
GG, GG-, GG gt GG-
GG, EE-, EE gt EE-
GG, EE-, GG gt EE-
EE GG
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Ratings Getting and giving up bads

• Valence Loss Possession Gain
• Imagine that you wake up one day with a really
  bad zit right on the tip of your nose. How
  unhappy would you feel about getting the zit?
• Valence Gain Possession Loss
• Imagine that you wake up one day, and a really
  bad zit that used to be on the tip of your nose
  has disappeared! How happy would you feel about
  the zit going away?

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Ratings Getting and giving up bads

• Get zit unhappy rating 6.0 (on 1-9 scale)
• Lose zit happy rating 6.5
• Get side effects unhappy rating 6.1
• Lose side effects happy rating 6.9

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Still more flavors of loss aversion

• Defining loom larger
• Looming as valuation (intensity of feeling)
• Losses feel worse than gains feel good

• Looming as attention/salience
• Losses dominate attention more than gains

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Hotel Choice
Golden Palms Better condition, worse
location Ocean View Better location, worse
condition
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Hotel Choice
Golden Palms Better condition, worse
location Ocean View Better location, worse
condition
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Hotel Choice Mediation/decomposition of
endowment effect
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Summary

• Different definitions of losses gains ?
  different flavors of loss aversion (PLA VLA)
• Patterns of EE and GG effects Evidence for PLA
  in addition to (or in place of) VLA
• Different definitions of loom larger ?
  different flavors of loss aversion
• Evidence for both attentional and valuation
  components