Loss Aversion Bias

Loss Aversion can be described as a phenomenon where an individual will perceive a real or potential loss as to be harsher than an equivalent gain.

It is theorized that the pain suffered by a loss, when compared with the pleasure a gain provides, is felt asymmetrically to the point of it having a twice as powerful effect on the individual’s psychological and/or emotional levels.

A 2016 study conducted by Schindler and Pfattheicher entitled “The frame of the game: Loss-framing increases dishonest behavior” and published in the Journal of Experimental Social Psychology, concluded that people will take and even behave dishonestly to reduce the extent of a loss compared, of course, to increasing the extent of a gain.

The Loss aversion bias gain be detrimental in evaluating possible gains as it leads to risk aversion and too conservative portfolios and underperformance in the market.

Loss Aversion Bias History

Amos Tversky and Nobel Prize-winning economist Daniel Kahneman were the first researchers to demonstrate this concept and, since then, it has been of importance in both the fields of marketing and behavioral economics.

His study was based on a coin flip and a simple premise: Kahneman told his students that if a flipped coin landed on tails, they would be down $10.

He then asked participants how much would be needed to win to make up for the risk of losing $10 on the coin flip. The answer, he said, was typically more than $20.

Other possible applications of the Loss Aversion bias:

This concept has been used to describe the reasoning behind both the endowment effect and the sunk cost fallacy.

It is also theorized that the loss aversion bias is a possible explanation to why penalties can be more effective than rewards in motivational terms. To no surprise this bias has been incorporated in several behavior change strategies.