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Showing papers on "Loss aversion published in 2012"


Journal ArticleDOI
TL;DR: The behavioral agency model suggests that to preserve socioemotional wealth, loss-averse family firms usually invest less in R&D than non-family firms as discussed by the authors, however, behavioral agency models predictions a...
Abstract: The behavioral agency model suggests that to preserve socioemotional wealth, loss-averse family firms usually invest less in R&D than nonfamily firms. However, behavioral agency model predictions a...

991 citations


Journal ArticleDOI
TL;DR: The authors discuss the relative role of beliefs, preferences, and technology in the anomalous impacts of incentives and argue that inference, signaling, loss aversion, dynamic inconsistency, and choking are the primary factors that explain the data.
Abstract: Monetary incentives can backfire while nonstandard interventions, such as framing, can be effective in influencing behavior. I review the empirical evidence on these two sets of anomalies. Paying for inherently interesting tasks, paying for prosocial behavior, paying too much, paying too little, and providing too many options can all be counterproductive. At the same time, proper design of the decision-making environment can be a potent way to induce certain behaviors. After presenting the empirical evidence, I discuss the relative role of beliefs, preferences, and technology in the anomalous impacts of incentives. I argue that inference, signaling, loss aversion, dynamic inconsistency, and choking are the primary factors that explain the data.

307 citations


Journal ArticleDOI
TL;DR: Prospect theory, first described in a 1979 paper by Daniel Kahneman and Amos Tversky, is widely viewed as the best available description of how people evaluate risk in experimental settings as mentioned in this paper.
Abstract: Prospect theory, first described in a 1979 paper by Daniel Kahneman and Amos Tversky, is widely viewed as the best available description of how people evaluate risk in experimental settings. While the theory contains many remarkable insights, it has proven challenging to apply these insights in economic settings, and it is only recently that there has been real progress in doing so. In this paper, after first reviewing prospect theory and the difficulties inherent in applying it, I discuss some of this recent work. It is too early to declare this research effort an unqualified success. But the rapid progress of the last decade makes me optimistic that at least some of the insights of prospect theory will eventually find a permanent and significant place in mainstream economic analysis.

267 citations


Journal ArticleDOI
TL;DR: Cachon et al. as discussed by the authors used framing manipulations to increase worker productivity in a Chinese high-tech manufacturing facility and found that repeated interaction with workers and conditionality of the bonus contract are substitutes for sustenance of incentive effects in the long run.
Abstract: Recent discoveries in behavioral economics have led to important new insights concerning what can happen in markets. Such gains in knowledge have come primarily via laboratory experiments---a missing piece of the puzzle in many cases is parallel evidence drawn from naturally occurring field counterparts. We provide a small movement in this direction by taking advantage of a unique opportunity to work with a Chinese high-tech manufacturing facility. Our study revolves around using insights gained from one of the most influential lines of behavioral research---framing manipulations---in an attempt to increase worker productivity in the facility. Using a natural field experiment, we report several insights. For example, conditional incentives framed as both “losses” and “gains” increase productivity for both individuals and teams. In addition, teams more acutely respond to bonuses posed as losses than as comparable bonuses posed as gains. The magnitude of this framing effect is roughly 1%: that is, total team productivity is enhanced by 1% purely due to the framing manipulation. Importantly, we find that neither the framing nor the incentive effect lose their significance over time; rather, the effects are observed over the entire sample period. Moreover, we learn that repeated interaction with workers and conditionality of the bonus contract are substitutes for sustenance of incentive effects in the long run. This paper was accepted by Gerard P. Cachon, decision analysis.

247 citations


Journal ArticleDOI
Evan Polman1
TL;DR: The authors found that making choices for others involves less loss aversion than choosing choices for the self, and that loss aversion is significantly lessened among people choosing for others in scenarios describing riskless choice.

214 citations


Journal ArticleDOI
TL;DR: This article examined how investor preferences and beliefs affect trading in relation to past gains and losses and found that the probability of selling as a function of profit is V-shaped; at short holding periods, investors are more likely to sell big losers than small ones.
Abstract: We examine how investor preferences and beliefs affect trading in relation to past gains and losses. The probability of selling as a function of profit is V-shaped; at short holding periods, investors are more likely to sell big losers than small ones. There is little evidence of an upward jump in selling at zero profits. These findings provide no clear indication that realization preference explains trading. Furthermore, the disposition effect is not driven by a simple direct preference for selling a stock by virtue of having a gain versus loss. Trading based on belief revisions can potentially explain these findings.

206 citations


Journal ArticleDOI
TL;DR: In this article, the authors use data on insurance deductible choices to estimate a structural model of risky choice that incorporates "standard" risk aversion (diminishing marginal utility for wealth) and probability distortions.
Abstract: We use data on insurance deductible choices to estimate a structural model of risky choice that incorporates 'standard' risk aversion (diminishing marginal utility for wealth) and probability distortions. We find that probability distortions - characterized by substantial overweighting of small probabilities and only mild insensitivity to probability changes - play an important role in explaining the aversion to risk manifested in deductible choices. This finding is robust to allowing for observed and unobserved heterogeneity in preferences. We demonstrate that neither Kőszegi-Rabin loss aversion alone nor Gul disappointment aversion alone can explain our estimated probability distortions, signifying a key role for probability weighting.

167 citations


Journal ArticleDOI
TL;DR: In this article, the authors show that manipulations that reduce the gap between valuations and reference prices reduce or eliminate the endowment effect, which is often best interpreted as an aversion to bad deals rather than an aversion of losing possessions.
Abstract: The common finding that selling prices exceed buying prices (the so-called endowment effect) is typically explained by the assumptions that consumers evaluate potential transactions with respect to their current holdings and that the owners of a good regard its potential loss to be more significant than nonowners regard its potential acquisition. In contrast to this “pain-of-losing” account, the authors propose that the endowment effect reflects a reluctance to trade on terms that appear unfavorable with respect to salient reference prices. In six experiments (and eight more summarized in appendixes), the authors show that manipulations that reduce the gap between valuations and reference prices reduce or eliminate the endowment effect. These results suggest that the endowment effect is often best construed as an aversion to bad deals rather than an aversion to losing possessions.

141 citations


Journal ArticleDOI
TL;DR: Overall, loss aversion appears to be sensitive to evolutionarily important motives, suggesting that it may be a domain-specific bias operating according to an adaptive logic of recurring threats and opportunities in different evolutionary domains.
Abstract: Much research shows that people are loss averse, meaning that they weigh losses more heavily than gains. Drawing on an evolutionary perspective, we propose that although loss aversion might have been adaptive for solving challenges in the domain of self-protection, this may not be true for men in the domain of mating. Three experiments examine how loss aversion is influenced by mating and selfprotection motives. Findings reveal that mating motives selectively erased loss aversion in men. In contrast, self-protective motives led both men and women to become more loss averse. Overall, loss aversion appears to be sensitive to evolutionarily important motives, suggesting that it may be a domain-specific bias operating according to an adaptive logic of recurring threats and opportunities in different evolutionary domains.

125 citations


ReportDOI
TL;DR: In this article, the authors demonstrate that exploiting the power of loss aversion (teachers are paid in advance and asked to give back the money if their students do not improve sufficiently) increases math test scores between 0.201 and 0.398 (0.129) standard deviations.
Abstract: Domestic attempts to use financial incentives for teachers to increase student achievement have been ineffective. In this paper, we demonstrate that exploiting the power of loss aversion--teachers are paid in advance and asked to give back the money if their students do not improve sufficiently--increases math test scores between 0.201 (0.076) and 0.398 (0.129) standard deviations. This is equivalent to increasing teacher quality by more than one standard deviation. A second treatment arm, identical to the loss aversion treatment but implemented in the standard fashion, yields smaller and statistically insignificant results. This suggests it is loss aversion, rather than other features of the design or population sampled, that leads to the stark differences between our findings and past research.

115 citations


Journal ArticleDOI
TL;DR: Findings in the cingulate and in mainly bilateral IFG regions, blood-oxygenation-level-dependent activation decreased when participants chose to inflate the balloon as the probability of explosion increased, findings that are consistent with a reduced loss aversion signal.
Abstract: The inferior frontal gyrus/anterior insula (IFG/AI) and anterior cingulate cortex (ACC) are key regions involved in risk appraisal during decision making, but accounts of how these regions contribute to decision making under risk remain contested. To help clarify the roles of these and other related regions, we used a modified version of the Balloon Analogue Risk Task (Lejuez et al., Journal of Experimental Psychology: Applied, 8, 75–84, 2002) to distinguish between decision-making and feedback-related processes when participants decided to pursue a gain as the probability of loss increased parametrically. Specifically, we set out to test whether the ACC and IFG/AI regions correspond to loss aversion at the time of decision making in a way that is not confounded with either reward-seeking or infrequency effects. When participants chose to discontinue inflating the balloon (win option), we observed greater ACC and mainly bilateral IFG/AI activity at the time of decision as the probability of explosion increased, consistent with increased loss aversion but inconsistent with an infrequency effect. In contrast, we found robust vmPFC activity when participants chose to continue inflating the balloon (risky option), consistent with reward seeking. However, in the cingulate and in mainly bilateral IFG regions, blood-oxygenation-level-dependent activation decreased when participants chose to inflate the balloon as the probability of explosion increased, findings that are consistent with a reduced loss aversion signal. Our results highlight the existence of distinct reward-seeking and loss-averse signals during decision making, as well as the importance of distinguishing between decision and feedback signals.

Journal ArticleDOI
10 May 2012-Neuron
TL;DR: This paper used fMRI with a novel incentivized skill task to examine the neural processes underlying behavioral responses to performance-based pay, and found that individuals' performance increased with increasing incentives; however, very high incentive levels led to the paradoxical consequence of worse performance.

Journal ArticleDOI
TL;DR: It is shown that decision makers consider both G and MR and give greater weight to MR than G, indicating failure aversion in addition to loss aversion, and single reference point based models such as prospect theory cannot consistently account for these findings.
Abstract: The tri-reference point (TRP) theory takes into account minimum requirements (MR), the status quo (SQ), and goals (G) in decision making under risk. The 3 reference points demarcate risky outcomes and risk perception into 4 functional regions: success (expected value of x ≥ G), gain (SQ G > SQ. We present TRP assumptions and value functions and a mathematical formalization of the theory. We conducted empirical tests of crucial TRP predictions using both explicit and implicit reference points. We show that decision makers consider both G and MR and give greater weight to MR than G, indicating failure aversion (i.e., the disutility of a failure is greater than the utility of a success in the same task) in addition to loss aversion (i.e., the disutility of a loss is greater than the utility of the same amount of gain). Captured by a double-S shaped value function with 3 inflection points, risk preferences switched between risk seeking and risk aversion when the distribution of a gamble straddled a different reference point. The existence of MR (not G) significantly shifted choice preference toward risk aversion even when the outcome distribution of a gamble was well above the MR. Single reference point based models such as prospect theory cannot consistently account for these findings. The TRP theory provides simple guidelines for evaluating risky choices for individuals and organizational management. (PsycINFO Database Record (c) 2012 APA, all rights reserved). Language: en


Journal ArticleDOI
TL;DR: In this paper, the detrimental impact of betrayal aversion on investment has been investigated and the impact is substantial: holding fixed the probability of betrayal, the possibility of knowing that one has been betrayed reduces investment by about one-third.
Abstract: Recent research argues “betrayal aversion” leads many people to avoid risk more when a person, rather than nature, determines the outcome of uncertainty. However, past studies indicate that factors unrelated to betrayal aversion, such as loss aversion, could contribute to differences between treatments. Using a novel experiment design to isolate betrayal aversion, one that varies how strategic uncertainty is resolved, we provide rigorous evidence supporting the detrimental impact of betrayal aversion. The impact is substantial: holding fixed the probability of betrayal, the possibility of knowing that one has been betrayed reduces investment by about one-third. We suggest emotion-regulation underlies these results and helps to explain the importance of impersonal, institution-mediated exchange in promoting economic efficiency.

Journal ArticleDOI
TL;DR: In this article, the accountability mechanism was used to debiasing loss aversion in agency relations, where subjects take risky decisions that affect themselves and a passive recipient, and adding a requirement to justify their choices significantly reduced loss aversion.

Journal ArticleDOI
TL;DR: In this article, it was shown that in the presence of risk aversion, loss aversion, or type I error aversion, type I errors have a stronger effect on deterrence than type II errors.
Abstract: The economic theory of crime deterrence predicts that the conviction of an innocent individual (type I error) is as detrimental to deterrence as the acquittal of a guilty individual (type II error). In this paper, we qualify this result theoretically, showing that in the presence of risk aversion, loss aversion, or type I error aversion, type I errors have a stronger effect on deterrence than type II errors. We test these predictions with two experimental studies in which participants choose whether to steal from other individuals, under alternative combinations of probabilities of judicial errors. The results indicate that both types of errors have a significant impact on deterrence. As predicted, type I errors have a stronger impact on deterrence than type II errors. This asymmetry is entirely explained by differences in the expected utility gains from crime, whereas nonexpected utility factors do not play a significant role.

Journal ArticleDOI
TL;DR: In this paper, the authors extended the framework proposed by Barberis and Huang (2009) to incorporate narrow framing and loss aversion into dynamic models of portfolio choice and asset pricing to also account for probability weighting and for a value function that is convex on losses and concave on gains.
Abstract: This paper shows that the framework proposed by Barberis and Huang (2009) to incorporate narrow framing and loss aversion into dynamic models of portfolio choice and asset pricing can be extended to also account for probability weighting and for a value function that is convex on losses and concave on gains. We show that the addition of probability weighting and a convex-concave value function reinforces previous applications of narrow framing and cumulative prospect theory to understanding the stock market non-participation puzzle and the equity premium puzzle. Moreover, we show that a convex-concave value function generates new wealth eff ects that are consistent with empirical observations on stock market participation.

Journal ArticleDOI
TL;DR: This article developed a dynamic general equilibrium model where households' utility depends on consumption deviations from a reference level below which loss aversion is displayed, and the resulting state-dependent trade-off between output and infl¾ation stabilization recommends stronger policy activism towards in¾flation during expansions.
Abstract: There is widespread evidence that monetary policy exerts asymmetric effects on output over contractions and expansions in economic activity, while price responses display no sizeable asymmetry. To rationalize these facts we develop a dynamic general equilibrium model where households' ’utility depends on consumption deviations from a reference level below which loss aversion is displayed. In line with the prospect theory pioneered by Kahneman and Tversky (1979), losses in consumption loom larger than gains. State-dependent degrees of real rigidity and elasticity of intertemporal substitution in consumption generate competing effects on output and infl‡ation. The resulting state-dependent trade-off between output and infl‡ation stabilization recommends stronger policy activism towards in‡flation during expansions.

Journal ArticleDOI
TL;DR: In the first stage, the same subjects are given the opportunity to trade this good for another good of similar value, such as a pen, and the endowment effect holds that very few subjects chose to trade as mentioned in this paper.
Abstract: Starting with Knetsch (1989), experiments on the “endowment effect” (Thaler 1980) typically rely on a two-stage procedure In the first stage, subjects are endowed with a good, such as a mug In the second stage, the same subjects are given the opportunity to trade this good for another good of similar value, such as a pen The endowment effect holds that very few subjects chose to trade, sometimes as few as ten percent In related experiments, subjects state selling prices for their endowment that are much higher than their buying prices for the same good These patterns are hard to reconcile with standard choice theory, which predicts that about half the subjects would trade and that selling prices and buying prices are similar The common explanation of this evidence relies on prospect theory’s loss aversion (Tversky and Kahneman 1979) Because the pain of parting with the endowment looms larger in the decision maker’s mind than the pleasure of acquiring a good of similar value (Kahneman, Knetsch, and Thaler 1990), a decision maker endowed with a mug is unwilling to trade it for a

Posted Content
TL;DR: This article introduced the notion of the default pull as the effect that even subtle default options have on decision makers' uncertainty about their own preferences, and demonstrated default pull effects using a simple decision-making task that strips away many of the usual reasons that defaults could affect choices.
Abstract: The impact of default options on choice is a reliable, well-established behavioral finding However, several different effects may lend to choosing defaults in an often indistinguishable manner, including loss aversion, inattention, information leakage, and transaction costs associated with switching We introduce the notion of the “default pull” as the effect that even subtle default options have on decision makers’ uncertainty about their own preferences The default pull shapes what a decision maker prefers by causing her to consider whether she prefers the default We demonstrate default pull effects using a simple decision making task that strips away many of the usual reasons that defaults could affect choices, and we show that defaults can have substantial effects on choice, even when the default itself was not

Journal ArticleDOI
TL;DR: In this paper, the authors extended the framework proposed by Barberis and Huang (2009) to incorporate narrow framing and loss aversion into dynamic models of portfolio choice and asset pricing to also account for probability weighting and for a value function that is convex on losses and concave on gains.

Journal ArticleDOI
TL;DR: In this paper, a cover version of the Heidhues-Kőszegi-Rabin model is proposed to analyze optimal pricing when consumers are loss averse in the sense that an unexpected price hike lowers their willingness to pay.
Abstract: This paper reformulates and simplifies a recent model by Heidhues and Kőszegi (The impact of consumer loss aversion on pricing, Mimeo, 2005), which in turn is based on a behavioral model due to Kőszegi and Rabin (Q J Econ 121:1133–1166, 2006). The model analyzes optimal pricing when consumers are loss averse in the sense that an unexpected price hike lowers their willingness to pay. The main message of the Heidhues–Kőszegi model, namely that this form of consumer loss aversion leads to rigid price responses to cost fluctuations, carries over. I demonstrate the usefulness of this “cover version” of the Heidhues–Kőszegi-Rabin model by obtaining new results: (1) loss aversion lowers expected prices; (2) the firm’s incentive to adopt a rigid pricing strategy is stronger when fluctuations are in demand rather than in costs.

Posted Content
TL;DR: In this paper, the authors demonstrate that exploiting the power of loss aversion (teachers are paid in advance and asked to give back the money if their students do not improve sufficiently) increases math test scores between 0.201 and 0.398 (0.129) standard deviations.
Abstract: Domestic attempts to use financial incentives for teachers to increase student achievement have been ineffective. In this paper, we demonstrate that exploiting the power of loss aversion--teachers are paid in advance and asked to give back the money if their students do not improve sufficiently--increases math test scores between 0.201 (0.076) and 0.398 (0.129) standard deviations. This is equivalent to increasing teacher quality by more than one standard deviation. A second treatment arm, identical to the loss aversion treatment but implemented in the standard fashion, yields smaller and statistically insignificant results. This suggests it is loss aversion, rather than other features of the design or population sampled, that leads to the stark differences between our findings and past research.

Journal ArticleDOI
TL;DR: The authors found that sampling from a student population leads to lower estimates of average risk aversion and loss aversion parameters and dramatically reduces the amount of heterogeneity in all parameters, while self-selection within a broad population does not seem to matter for average preferences.
Abstract: An ever increasing number of experiments attempts to elicit risk preferences of a population of interest with the aim of calibrating parameters used in economic models. We are concerned with two types of selection effects, which may affect the external validity of standard experiments: Sampling from a narrowly defined population of students (“experimenter-induced selection”) and self-selection due to non-response or incomplete response of participants in a random sample from a broad population. We find that both types of selection lead to a sample of experts: Participants perform significantly better than the general population, in the sense of fewer violations of revealed preference conditions. Self-selection within a broad population does not seem to matter for average preferences. In contrast, sampling from a student population leads to lower estimates of average risk aversion and loss aversion parameters. Furthermore, it dramatically reduces the amount of heterogeneity in all parameters.

Journal ArticleDOI
TL;DR: In this article, the authors look into heterogeneity in loss aversion in order to detect how dispersed loss aversion is in tourism and to observe whether different degrees of loss aversion can lead to the identification of loss-aversion-based segments.
Abstract: The objective of this article is to look into heterogeneity in loss aversion in order to detect how dispersed loss aversion is in tourism and to observe whether different degrees of loss aversion can lead to the identification of loss-aversion–based segments. Loss aversion is a prominent psychological human trait that causes asymmetric price reactions. Tourism literature has shown it is a critical characteristic with a significant, but heterogeneous, effect on tourist destination choice. However, so far no attempt has been made to look into loss aversion heterogeneity, and this article contributes to the literature by exploring, for the first time, the potential existence of groups of tourists that show differentiated asymmetric responses to price. The empirical application estimates the individual degree of loss aversion for each tourist, and detects five segments with different sensitivities. Relevant managerial implications are drawn in terms of implementing pricing strategies.

Journal ArticleDOI
TL;DR: This paper proposed a policy bundling technique in which related bills involving both losses and gains are combined to offset separate bills' costs while preserving their net benefits, which can transform unpopular individual pieces of legislation, which would lack the support for implementation, into more popular policies.

Journal ArticleDOI
21 Nov 2012-PLOS ONE
TL;DR: A simple binary-choice model is developed that shows how intelligence can emerge via selection, why it may be bounded, and how such bounds typically imply the coexistence of multiple levels and types of intelligence as a reflection of varying environmental conditions.
Abstract: Background: Most economic theories are based on the premise that individuals maximize their own self-interest and correctly incorporate the structure of their environment into all decisions, thanks to human intelligence. The influence of this paradigm goes far beyond academia–it underlies current macroeconomic and monetary policies, and is also an integral part of existing financial regulations. However, there is mounting empirical and experimental evidence, including the recent financial crisis, suggesting that humans do not always behave rationally, but often make seemingly random and suboptimal decisions. Methods and Findings: Here we propose to reconcile these contradictory perspectives by developing a simple binarychoice model that takes evolutionary consequences of decisions into account as well as the role of intelligence, which we define as any ability of an individual to increase its genetic success. If no intelligence is present, our model produces results consistent with prior literature and shows that risks that are independent across individuals in a generation generally lead to risk-neutral behaviors, but that risks that are correlated across a generation can lead to behaviors such as risk aversion, loss aversion, probability matching, and randomization. When intelligence is present the nature of risk also matters, and we show that even when risks are independent, either risk-neutral behavior or probability matching will occur depending upon the cost of intelligence in terms of reproductive success. In the case of correlated risks, we derive an implicit formula that shows how intelligence can emerge via selection, why it may be bounded, and how such bounds typically imply the coexistence of multiple levels and types of intelligence as a reflection of varying environmental conditions. Conclusions: Rational economic behavior in which individuals maximize their own self interest is only one of many possible types of behavior that arise from natural selection. The key to understanding which types of behavior are more likely to survive is how behavior affects reproductive success in a given population’s environment. From this perspective, intelligence is naturally defined as behavior that increases the probability of reproductive success, and bounds on rationality are determined by physiological and environmental constraints.

01 Jan 2012
TL;DR: The authors argue that human decision processes are susceptible to several illusions: those caused by heuristic decision-making processes, as well as those arising from the adoption of "mental frames." Unfortunately, these heuristics may lead to cognitive illusions that include representativeness, overconfidence, anchoring, gambler's fallacy, loss aversion, regret aversion, and mental accounting.
Abstract: The efficient markets hypothesis (EMH) has posited investment decision-makers as rational, utility-maximizing individuals. Cognitive psychology, on the other hand, suggests that human decision processes are susceptible to several illusions: those caused by heuristic decision-making processes, as well as those arising from the adoption of "mental frames." Unfortunately, these heuristics may lead to cognitive illusions that include: representativeness, overconfidence, anchoring, gambler's fallacy, loss aversion, regret aversion, and mental accounting, among others. Behavioral finance proponents argue that heuristic-driven bias and framing effects cause market prices to deviate from fundamental values. This field amalgamates theories from financial economics, psychology, and sociology in an attempt to construct a more “complete” model that incorporates the idiosyncrasies of human behavior in financial markets. This paper argues that understanding of the findings of this research benefits individual investors the most as it seeks to create awareness of the various human biases and the high costs they impose on their portfolios.

Journal ArticleDOI
Baler Bilgin1
TL;DR: In this article, the authors reveal a subjective probability-based asymmetry between gains and losses that may contribute to loss aversion in risky choice, with the propensity of losses to attract attention and to be subsequently imagined appearing to underlie the proposed asymmetry.