Showing papers on "Loss aversion published in 2011"
TL;DR: This paper found that effort provision is significantly different between treatments in the way predicted by models of expectation-based reference-dependent preferences: if expectations are high, subjects work longer and earn more money than if expectations were low.
Abstract: A key open question for theories of reference-dependent preferences is what determines the reference point. One candidate is expectations: what people expect could affect how they feel about what actually occurs. In a real-effort experiment, we manipulate the rational expectations of subjects and check whether this manipulation influences their effort provision. We find that effort provision is significantly different between treatments in the way predicted by models of expectation-based reference-dependent preferences: if expectations are high, subjects work longer and earn more money than if expectations are low.
469 citations
TL;DR: This article found evidence that even the best golfers -including Tiger Woods - show evidence of loss aversion in their performance on the PGA Tour, where golfers are rewarded for the total number of strokes they take during a tournament and each individual hole has a salient reference point, par.
Abstract: Although experimental studies have documented systematic decision errors, many leading scholars believe that experience, competition, and large stakes will reliably extinguish biases. We test for the presence of a fundamental bias, loss aversion, in a high-stakes context: professional golfers' performance on the PGA Tour Golf provides a natural setting to test for loss aversion because golfers are rewarded for the total number of strokes they take during a tournament, yet each individual hole has a salient reference point, par. We analyze over 2.5 million putts using precise laser measurements and find evidence that even the best golfers - including Tiger Woods - show evidence of loss aversion. (JEL D03, D81, L83)
437 citations
TL;DR: This article proposed that the concept of emotional attachment, and specifically the independent constructs of psychological ownership and affective reaction, can help explain many of the endowment effect findings documented in the literature.
273 citations
TL;DR: In this paper, the authors analyse risk preferences using an experiment with real incentives in a representative sample of 1,422 Dutch respondents and find that four structural parameters contribute to explaining choice behavior.
Abstract: We analyse risk preferences using an experiment with real incentives in a representative sample of 1,422 Dutch respondents. Our econometric model incorporates four structural parameters that vary with observed and unobserved characteristics: Utility curvature, loss aversion, preferences towards the timing of uncertainty resolution, and the propensity to choose randomly rather than on the basis of preferences. We find that all four parameters contribute to explaining choice behaviour. The structural parameters are significantly associated with socio-economic variables, but it is essential to incorporate unobserved heterogeneity in each of them to match the rich variety of choice patterns in the data.
253 citations
TL;DR: Xiong et al. as discussed by the authors formulated and carried out an analytical treatment of a single-period portfolio choice model featuring a reference point in wealth, S-shaped utility (value) functions with loss aversion, and probability weighting under Kahneman and Tversky's cumulative prospect theory.
Abstract: We formulate and carry out an analytical treatment of a single-period portfolio choice model featuring a reference point in wealth, S-shaped utility (value) functions with loss aversion, and probability weighting under Kahneman and Tversky's cumulative prospect theory (CPT). We introduce a new measure of loss aversion for large payoffs, called the large-loss aversion degree (LLAD), and show that it is a critical determinant of the well-posedness of the model. The sensitivity of the CPT value function with respect to the stock allocation is then investigated, which, as a by-product, demonstrates that this function is neither concave nor convex. We finally derive optimal solutions explicitly for the cases in which the reference point is the risk-free return and those in which it is not (while the utility function is piecewise linear), and we employ these results to investigate comparative statics of optimal risky exposures with respect to the reference point, the LLAD, and the curvature of the probability weighting.
This paper was accepted by Wei Xiong, finance.
194 citations
TL;DR: In this paper, a hierarchical Bayesian parameter estimation procedure for cumulative prospect theory (CPT) has been proposed and applied to a real data set, showing that without particular constraints on the parameter space, CPT can produce loss aversion without the parameter associated with loss aversion.
184 citations
TL;DR: In this paper, the authors argue that the tendency of markets to neglect apparently cost-effective energy efficiency options has been called the “efficiency gap” or “energy paradox,” which is mainly produced by the combination of substantial uncertainty about the net value of future fuel savings and the loss aversion of typical consumers.
170 citations
TL;DR: The authors tracked the developmental trajectory of risk taking for gains and losses, and expected value (EV) sensitivity in risky choices, from childhood through older adulthood, and found that risk-taking decreased consistently across the lifespan.
Abstract: The ability to make advantageous decisions in the face of uncertainty is an essential human skill, yet the development of such abilities over the lifespan is still not well understood. In the current study, from childhood through older adulthood, we tracked the developmental trajectory of risk taking for gains and losses, and expected value (EV) sensitivity in risky choices. In the gain domain, risk-taking decreased consistently across the lifespan. In the loss domain, risk-taking was relatively constant across ages, a result we attribute to the pervasiveness of loss aversion. EV sensitivity showed an inverted-U-shaped function, increasing from childhood to adulthood but then decreasing for the elderly, which occurred for both risky gains and risky losses. This finding is consistent with neuropsychological and neuroanatomical evidence concerning the role of the frontal lobe in decision making, which is relatively late to develop during childhood but may degrade earlier in the later years. Copyright © 2010 John Wiley & Sons, Ltd.
158 citations
TL;DR: In this paper, the authors study the dynamic pricing implications of a new, behaviorally motivated reference price mechanism based on the peak-end memory mode, which suggests that consumers anchor on a reference price that is a weighted average of the lowest and most recent prices.
Abstract: We study the dynamic pricing implications of a new, behaviorally motivated reference price mechanism based on the peak-end memory mode. This model suggests that consumers anchor on a reference price that is a weighted average of the lowest and most recent prices. Loss-averse consumers are more sensitive to perceived losses than gains relative to this reference price. We find that a range of constant pricing policies is optimal for the corresponding dynamic pricing problem. This range is wider the more consumers anchor on lowest prices, and it persists when buyers are loss neutral, in contrast with previous literature. In a transient regime, the optimal pricing policy is monotone and converges to a steady-state price, which is lower the more extreme and salient the low-price anchor is. Our results suggest that behavioral regularities, such as peak-end anchoring and loss aversion, limit the benefits of varying prices, and caution that the adverse effects of deep discounts on the firm's optimal prices and profits might be more enduring than previous models predict.
157 citations
TL;DR: This paper found that sophisticated and more experienced investors are at least as loss averse as their counterparts and that loss aversion operated most strongly during the cycle peak in 2007, which suggests that the pricing and volume cycle during 2001-2009 was little affected by loss aversion.
Abstract: Loss aversion behavior plays a major role in the pricing of commercial properties, and it varies both across the type of market participants and across the cycle. We find that sophisticated and more experienced investors are at least as loss averse as their counterparts and that loss aversion operated most strongly during the cycle peak in 2007. We also document a possible anchoring effect of the asking price in influencing buyer valuation and subsequent transaction price. We demonstrate the importance of behavioral phenomena in constructing hedonic price indices, and we find that the impact of loss aversion is attenuated at the aggregate market level. This suggests that the pricing and volume cycle during 2001–2009 was little affected by loss aversion.
126 citations
TL;DR: In this article, the authors investigated the impact of monetary incentives in the gain domain and the loss domain on the degree of risk aversion of the subjects compared with three payment conditions: a real-losses condition based on a random-lottery (incentive-compatible) system, which serves as a benchmark, and two challengers, namely, a "losses-from-an-initial-endowment" procedure and a hypothetical loss condition.
Abstract: In the loss domain, both practical and ethical considerations rule out the systematic use of an incentive-compatible procedure involving real losses. The experimental study presented here aims at investigating whether some easier-to-implement procedure could be adequately used. For that purpose, the subjects’ degree of risk aversion is compared across three payment conditions: a real-losses condition based on a random-lottery (incentive-compatible) system, which serves as a benchmark, and two challengers, namely a “losses-from-an-initial-endowment” procedure and a hypothetical-losses condition. As a by-product, our experimental design also allows us to investigate the impact of monetary incentives in the gain domain. The main result is twofold: no significant difference arises between the three payment conditions in the loss domain, while real and hypothetical choices significantly differ in the gain domain. Our results suggest that the use of monetary incentives may be more crucial in the gain domain than in the loss domain.
TL;DR: In this article, a general equilibrium model is proposed to examine the implications of prospect theory for the disposition effect, asset prices, and trading volume of the stock market, which is helpful for understanding a wide range of financial phenomena and also suggests new testable predictions.
Abstract: We build a general equilibrium model to examine the implications of prospect theory for the disposition effect, asset prices, and trading volume. Diminishing sensitivity predicts a disposition effect, price momentum, a reduced return volatility, and a positive return-volume correlation. Loss aversion generally predicts the opposite. In calibrated economies, there is a nontrivial range of preference parameters for prospect theory to simultaneously explain the disposition effect, the momentum effect, and the equity premium puzzle. Our model is helpful for understanding a wide range of financial phenomena and it also suggests new testable predictions.
TL;DR: In this article, the authors investigated consumers' loss aversion when buying and selling a common product and found a significantly stronger activation in the amygdala while consumers estimate selling prices versus buying prices, suggesting that loss aversion is associated with the processing of negative emotion.
Abstract: Although the field of psychology is undergoing an immense shift toward the use of functional magnetic resonance imaging (fMRI), the application of this methodology to consumer research is relatively new. To assist consumer researchers in understanding fMRI, this paper elaborates on the findings of prior fMRI research related to consumer behavior and highlights the features that make fMRI an attractive method for consumer and marketing research. The authors discuss advantages and limitations and illustrate the proposed procedures with an applied study, which investigates loss aversion when buying and selling a common product. Results reveal a significantly stronger activation in the amygdala while consumers estimate selling prices versus buying prices, suggesting that loss aversion is associated with the processing of negative emotion. © 2011 Wiley Periodicals, Inc.
TL;DR: In this article, Wu et al. report on the results of an experimental elicitation at the individual level of all prospect theory components (i.e., utility, loss aversion, and weighting functions) in two decision contexts: situations where alternatives are described as probability distributions and situations where the decision maker must experience unknown probability distributions through sampling before choice.
Abstract: This paper reports on the results of an experimental elicitation at the individual level of all prospect theory components (i.e., utility, loss aversion, and weighting functions) in two decision contexts: situations where alternatives are described as probability distributions and situations where the decision maker must experience unknown probability distributions through sampling before choice. For description-based decisions, our results are fully consistent with prospect theory's empirical findings under risk. Furthermore, no significant differences are detected across contexts as regards utility and loss aversion. Whereas decision weights exhibit similar qualitative properties across contexts typically found under prospect theory, our data suggest that, for gains at least, the subjective treatment of uncertainty in experience-based and description-based decisions is significantly different. More specifically, we observe a less pronounced overweighting of small probabilities and a more pronounced underweighting of moderate and high probabilities for experience-based decisions. On the contrary, for losses, no significant differences were observed in the evaluation of prospects across contexts.
This paper was accepted by George Wu, decision analysis.
TL;DR: The authors examined the role of the autonomic Nervous system in decisions under uncertainty and its consistency with the behavioral responses, and showed that losses lead to heightened autonomic responses, compared to equivalent gains, even in situations where the average decision maker exhibits no loss aversion.
Abstract: The common view in psychology and neuroscience is that losses loom larger than gains, leading to a negativity bias in behavioral responses and Autonomic Nervous System (ANS) activation. However, evidence has accumulated that in decisions under risk and uncertainty individuals often impart similar weights to negative and positive outcomes. We examine the role of the ANS in decisions under uncertainty, and its consistency with the behavioral responses. In three studies, we show that losses lead to heightened autonomic responses, compared to equivalent gains (as indicated by pupil dilation and increased heart rate) even in situations where the average decision maker exhibits no loss aversion. Moreover, in the studied tasks autonomic responses were not associated with risk taking propensities. These results are interpreted by the hypothesis that losses signal the subjective importance of global outcome patterns. Copyright © 2010 John Wiley & Sons, Ltd.
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TL;DR: In this article, the authors analyzed the accuracy of 6,234 undisclosed, company-internal sales forecasts, which German firms provided anonymously to the IAB Establishment Panel, and revealed the average forecast to be signi cantly overpessimistic.
Abstract: Previous empirical evidence which evaluated the accuracy of management earnings or sales forecasts consistently revealed these forecasts to be on average signi cantly overoptimistic. However, all studies analyzed forecasts from public disclosures, which are an important signal to investors and analysts and thus possibly biased by strategic considerations. To disentagle whether and to which extent strategic deception or cognitive biases are resposible for this overoptimism, the present study analyzes the accuracy of 6,234 undisclosed, company-internal sales forecasts, which German firms provided anonymously to the IAB Establishment Panel. Quite surprisingly, the study reveals the average forecast to be signi cantly overpessimistic. I propose that the non-existence of a general bias towards overoptimism is due to the lack of incentives to consciously overgloss future prospects in undisclosed forecasts and that overpessimism may be a consequence of loss aversion.
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TL;DR: The results suggest the importance of aspiration levels, and thus the overall probability to break even, under time pressure, and the implications of the findings for decision-making situations that involve time pressure.
Abstract: We study the effects of time pressure on risky decisions for pure gain prospects, pure loss prospects, and mixed prospects involving both gains and losses. In an experiment we find that risk aversion for gains is robust under time pressure whereas risk seeking for losses turns into risk aversion under time pressure. For mixed prospects, subjects become more loss averse and more gain seeking under time pressure, depending on the framing of the prospects. The results suggest the importance of aspiration levels under time pressure. We discuss the implications of our findings for decision making situations that involve time pressure.
TL;DR: For instance, the authors argued that loss aversion is nothing more than an affective forecasting error, while others have argued that there are many situations in which losses are actually more impactful than comparable gains.
TL;DR: The authors developed an estimation strategy that can point identify the effects of loss aversion and equity constraints on selling prices using a long panel of data from the San Francisco Bay Area real estate market.
TL;DR: Testing the prevalence of three risk-based biases among 206 individuals in the USDA Forest Service with authority to choose how to manage a wildfire event indicates that the subjects exhibited loss aversion, choosing the safe option more often when the consequences of the choice were framed as potential gains.
Abstract: Managing wildfire events to achieve multiple management objectives involves a high degree of decision complexity and uncertainty, increasing the likelihood that decisions will be informed by experience-based heuristics triggered by available cues at the time of the decision. The research reported here tests the prevalence of three risk-based biases among 206 individuals in the USDA Forest Service with authority to choose how to manage a wildfire event (i.e., line officers and incident command personnel). The results indicate that the subjects exhibited loss aversion, choosing the safe option more often when the consequences of the choice were framed as potential gains, but this tendency was less pronounced among those with risk seeking attitudes. The subjects also exhibited discounting, choosing to minimize short-term over long-term risk due to a belief that future risk could be controlled, but this tendency was less pronounced among those with more experience. Finally, the subjects, in particular those with more experience, demonstrated a status quo bias, choosing suppression more often when their reported status quo was suppression. The results of this study point to a need to carefully construct the decision process to ensure that the uncertainty and conflicting objectives inherent in wildfire management do not result in the overuse of common heuristics. Individual attitudes toward risk or an agency culture of risk aversion may counterbalance such heuristics, whereas increased experience may lead to overconfident intuitive judgments and a failure to incorporate new and relevant information into the decision.
TL;DR: In this article, responsibility aversion is defined as the preference to minimize one's causal role in outcome generation, and the results of five studies support a responsibility aversion motivation behind uncertainty-seeking behavior.
TL;DR: In this article, the security market line theorem (SMLT) of the CAPM is intact in the CPT framework, and therefore the SMLT is intact also in the PT framework.
Abstract: Markowitz and Sharpe won the Nobel Prize in Economics for the development of Mean-Variance (M-V) analysis and the Capital Asset Pricing Model (CAPM). Kahneman won the Nobel Prize in Economics for the development of Prospect Theory. In deriving the CAPM, Sharpe, Lintner and Mossin assume expected utility (EU) maximization in the face of risk aversion. Kahneman and Tversky suggest Prospect Theory (PT) as an alternative paradigm to EU theory. They show that investors distort probabilities, make decisions based on change of wealth, exhibit loss aversion and maximize the expectation of an S-shaped value function, which contains a risk-seeking segment. Can these two apparently contradictory paradigms coexist? We show in this paper that although CPT (and PT) is in conflict to EUT, and violates some of the CAPM’s underlying assumptions, the Security Market Line Theorem (SMLT) of the CAPM is intact in the CPT framework. Therefore, the CAPM is intact also in CPT framework.
TL;DR: Prospect theory, an empirically correct theory of choice under risk that deals precisely with this condition, therefore seems to have much to offer in political decision-making as discussed by the authors, which is a central feature of political decision making.
Abstract: Risk is a central feature of political decision making. Prospect theory, an empirically correct theory of choice under risk that deals precisely with this condition, therefore seems to have much to...
TL;DR: This paper finds preference reversals in measurements of ambiguity aversion, even if psychological and informational circumstances are kept constant, and offers an explanation based on Sugden's random-reference theory, with different elicitation methods generating different random reference points.
Abstract: This paper finds preference reversals in measurements of ambiguity aversion, even if psychological and informational circumstances are kept constant. The reversals are of a fundamentally different nature than the reversals found before because they cannot be explained by context-dependent weightings of attributes. We offer an explanation based on Sugden's random-reference theory, with different elicitation methods generating different random reference points. Then measurements of ambiguity aversion that use willingness to pay are confounded by loss aversion and hence overestimate ambiguity aversion.
This paper was accepted by Teck Ho, decision analysis.
TL;DR: In this paper, the authors present results from the first large-scale international survey on risk preferences, conducted in 45 countries and show substantial cross-country differences in risk aversion, loss aversion and probability weighting.
Abstract: We present results from the first large-scale international survey on risk preferences, conducted in 45 countries. We show substantial cross-country differences in risk aversion, loss aversion and probability weighting. Moreover, risk attitudes in our sample depend not only on economic conditions, but also on cultural factors, as measured by the Hofstede dimensions Individuality and Uncertainty Avoidance. The presented data might also serve as an interesting starting point for further research in cultural economics.
TL;DR: In this paper, the optimal investment strategy for defined contribution pension plan members is a target-driven "threshold" strategy, where the equity allocation is increased if the accumulating fund is below target and decreased if it is above.
Abstract: Assuming loss aversion, stochastic investment and labor income processes, and a path-dependent target fund, we show that the optimal investment strategy for defined contribution pension plan members is a target-driven 'threshold' strategy. With this strategy, the equity allocation is increased if the accumulating fund is below target and decreased if it is above. However, if the fund is sufficiently above target, the optimal investment strategy switches discretely to 'portfolio insurance'. We show that under loss aversion, the risk of failing to attain the target replacement ratio is significantly reduced compared with target-driven strategies derived from maximizing expected utility.
TL;DR: In this article, the implications of consumer reference dependence in market competition were studied. And the welfare impact of consumer relation dependence on advertising was analyzed. But the authors focused on the negative impact of consumers' reference dependence on firms' advertising strategies and quality choices.
Abstract: This paper studies the implications of consumer reference dependence in market competition. If consumers take some product (e.g., the first product they have considered) as the reference point in evaluating others and exhibit loss aversion, then the more "prominent" firm whose product is taken as the reference point by more consumers will randomize its price over a high and a low one. All else equal, this firm will on average earn a larger market share and a higher profit than its rival. The welfare impact is that consumer reference dependence could harm firms and benefit consumers by intensifying price competition. Consumer reference dependence will also shape firms' advertising strategies and quality choices. If advertising increases product prominence, ex ante identical firms may differentiate their advertising intensities. If firms vary in their prominence, the less prominent firm might supply a lower-quality product even if improving quality is costless.
TL;DR: This paper proposed a new account of the evidence, based on the assumptions that individuals are affected by good and bad deals relative to the expected transaction price (price sensitivity), with bad deals having a larger impact on their utility (bad-deal aversion).
Abstract: Several experimental studies have reported that an otherwise robust regularity—the disparity between Willingness-To-Accept and Willingness-To-Pay—tends to be greatly reduced in repeated markets, posing a serious challenge to existing reference-dependent and reference-independent models alike. This article offers a new account of the evidence, based on the assumptions that individuals are affected by good and bad deals relative to the expected transaction price (price sensitivity), with bad deals having a larger impact on their utility (`bad-deal’ aversion). These features of preferences explain the existing evidence better than alternative approaches, including the most recent developments of loss aversion models.
TL;DR: In this paper, the authors used data from the 2007 Survey of Consumer Finances to examine household saving behavior based on the two-period model of consumption/saving presented by Bowman et al.
Abstract: This study uses data from the 2007 Survey of Consumer Finances to examine household saving behavior based on the two-period model of consumption/saving presented by Bowman et al. (Econ Behav Organ 38:155–178, 1999). The main focus of the model is the existence of an asymmetry in saving behavior in response to positive and negative adjustments in income. The results of the logistic regression analysis support the existence of loss aversion at the household level, where having income below the household’s reference level significantly decreases the likelihood of saving, but having income above the household’s reference level does not have a significant effect on the likelihood of saving.
TL;DR: An alternative method for de-escalating commitment is tested: activating broad motivations for growth and advancement (promotion), which should reduce concerns with loss and increase perceptions of alternatives, thereby attenuating justification motives.
Abstract: People frequently escalate their commitment to failing endeavors. Explanations for such behavior typically involve loss aversion, failure to recognize other alternatives, and concerns with justifying prior actions; all of these factors produce recommitment to previous decisions with the goal of erasing losses and vindicating these decisions. Solutions to escalation of commitment have therefore focused on external oversight and divided responsibility during decision making to attenuate loss aversion, blindness to alternatives, and justification biases. However, these solutions require substantial resources and have additional adverse effects. The present studies tested an alternative method for de-escalating commitment: activating broad motivations for growth and advancement (promotion). This approach should reduce concerns with loss and increase perceptions of alternatives, thereby attenuating justification motives. In two studies featuring hypothetical financial decisions, activating promotion motivations reduced recommitment to poorly performing investments as compared with both not activating any additional motivations and activating motivations for safety and security (prevention).