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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) < 0 or: |v(-X)| > 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 Choice: Endowment 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)| > v(get mug)
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Competing intuitions on staying vs. switching Endowment effect (EE): tendency to stay with what you’ve got; overly value your possessions Grass is greener (GG): tendency to switch to something else; overly value what you don’t 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 it’s 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 GainPossession Loss Valence Change Valence Gain Valence Loss
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Relationship between Valence and Possession Changes: Goods Possession Change Possession GainPossession Loss Valence Change Valence Gain Valence Loss With “Goods”, possession gain/loss and valence gain/loss are confounded (positively) Receive Mug Give up Mug
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Relationship between Valence and Possession Changes: Bads Possession Change Possession GainPossession Loss Valence Change Valence Gain Valence Loss With “Bads”, possession gain/loss and valence gain/loss are confounded (negatively) “Receive” nausea “Give up” nausea
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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, you’re 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% > 100% (endowment effect) Bads, Speeding penalties: $100 fine, or traffic school Fine default: 12% stay Traffic school default: 70% stay STAYSUM = 82% < 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% > 100% (endowment effect) Bads, Jobs: Long commute, or work weekends Commute default: 52% stay Work weekends default: 24% stay STAYSUM = 76% < 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% > 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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|VL|>VG PL>PG |VL|<VG PL<PG EE+, EE-, EE+ > EE- EE+, GG-, EE+ > GG- EE+, EE-, EE- > EE+ GG+, EE-, EE+ > EE- GG+, EE-, GG+ > EE- GG+, GG-, GG+ > GG- GG+, GG-, GG- > GG+ EE+, GG-, GG- > EE+ EE+ GG+ GG- EE- 3 2 1
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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
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