Loss Aversion Bias

Overcoming loss aversion leads to better opportunities not only in design, but in life in general. If you’re struggling to take risks due to loss aversion and find you can’t get past it on your own, you might consider working with a coach to overcome this and other cognitive biases. [Sources: 14]

However, we need to put this fear in perspective with our potential benefits. It makes us fear loss, even if that fear is illogical. For example, it prevents us from taking small risks for big profits. [Sources: 14]

Loss aversion is the tendency to avoid losses versus achieving an equivalent profit. In behavioral economics, loss aversion refers to people’s preference for avoiding losses over equivalent gains. [Sources: 2, 6]

For example, if someone gave us a bottle of PS300 wine, we could earn a small amount of happiness (utility). However, if we had a bottle of PS300 wine and it fell to the ground, we would be more miserable. [Sources: 2]

This meant that the psychological value (or intensity) of losing (-$ 500) was much greater than the value of winning (+ $ 500). Tversky and Kahneman (1992) have proposed that losses be estimated to be about 2.3 times the gain of the same value, while Baumeister et al. However, it has not been reliably proven that such biases occur in behavioral decision making studies, and instead it has been found that people generally give equal importance to gains and losses. In affective judgments, people exaggerate when they report their feelings about losses, but this may reflect a tendency to complain rather than true bias when comparing losses to results. [Sources: 1, 9]

We can note that mentally the effect of a loss on investor behavior is more important than the effect of profit, which characterizes loss aversion and explains the pessimism of an investor susceptible to this bias. Of course, it is true that large financial losses can have a greater impact than large financial gains, but this is not a cognitive bias requiring an explanation for loss aversion, but perfectly rational behavior. While the sunk cost effect may reflect a reluctance to recognize losses, it is not related to loss aversion, which requires a comparison of losses and gains. Similarly, there are other situations where losses are more significant than benefits, but these require specific explanations rather than general claims of loss aversion bias. [Sources: 0, 17]

For example, neuroeconomic research often proposes options up to the point where the gain is double the loss (eg, +4 versus $ -2; Tom et al., 2007). For example, “the value function is significantly steeper for losses than for gains” (Tversky and Kahneman, 1986, p. S255) and “asymmetry usually occurs because people expect the pain of losing something to outweigh the pleasure of getting it” ( McGraw et al., 2010, p. 1441). It lies in the fact that investors estimate profit and loss differently. An investor in this biased attitude uses profit to make a decision, not a loss, because he seeks to avoid the risk associated with a loss. [Sources: 1, 17]

Faced with a choice of avoiding a Rs 1,000 loss or making a Rs 1,000 profit, loss-averse investors would rather not make a loss than make a profit. Conversely, loss aversion can cause clients to hold onto investments that have lost value in order to avoid a loss in their portfolio, even if selling is a wise decision. Fear of loss can harm an investor, prompting him to hold onto losing investments long after they should have been sold, or dump winning stocks too early – a cognitive bias known as the disposition effect. Newbies often make the mistake of hoping for a recovery in stocks, despite all evidence to the contrary, because losses lead to stronger emotional reactions than profits. [Sources: 6, 13, 16]

Loss aversion is a reflection of the universal prejudice (status bias) of human psychology, which makes people resist change. Therefore, when we consider changes, we pay more attention to what we will lose rather than what we can achieve. [Sources: 11]

Experiencing the psychological consequences of loss, and even facing the possibility of loss, may even lead to risky behavior, making the realized loss more likely or more serious. Loss aversion in behavioral economics refers to the phenomenon that people think that actual or potential loss is psychologically or emotionally more serious than the same benefit. Loss aversion is a kind of cognitive bias, which refers to the tendency of humans to avoid losses in order to obtain the same benefits. [Sources: 8, 16]

Therefore, loss aversion is a principle that can explain many phenomena, such as status quo bias, sunk costs, especially the endowment effect that is often discussed (Tversky and Kahneman, 1991; Kahneman, 2003, 2011). Loss aversion, that is, the view that loss has a greater psychological impact than gain, is widely regarded as the most important point of view in behavioral decision-making, and it is also a related field of behavioral economics. The idea of ​​loss aversion was first proposed in an article entitled “Choice, Value, and Scope” published in 1984 by economists Kahneman and Tevers. [Sources: 0, 1, 14]

The study by Dr. Mei Wang surveyed groups from 53 different countries to understand how different cultural values ​​affect a person’s perception of loss versus gain. people from African countries are least afraid of loss. The cultural background of people can influence the extent to which they are averse to loss (for example, risk aversion is the avoidance of risk or the possibility of loss; this is reflected in the choice of investment. [Sources: 4, 10, 13]

For example, a person is less likely to invest in stocks if it is considered risky with the possibility of losing money, even if the reward potential is high. According to prospect theory, people prefer to avoid losses rather than gain profits. In business, loss aversion also means that companies that are doing well but not doing what they expected or others expected may behave unethically because they formulate their profit statement (but not as much profit as expected) as loss, not again. Loss aversion is tied to the concept of framing based on behavioral ethics, because the same situation can often be thought of as potential loss or potential gain, and the difference in framing can definitely influence people’s decisions. [Sources: 8, 15, 16]

However, for example, adjusting emotions from a different perspective can reduce loss aversion and help people overcome potentially unfavorable decision-making biases. Even if there is no need to choose, this individual difference in the internal reactivity of the internal perception system reflects the impact of the predicted negative impact on the evaluation process, which leads to a preference for avoiding losses, rather than gaining greater but riskier profits. Research has linked loss aversion to attention mechanisms (Yechiam and Hochman, 2013), so this is unlikely to be just a bias, but an information gathering strategy (Clay et al., 2017). David Gal (2006) believes that many phenomena usually attributed to loss aversion, including status quo bias, innate effects, and preference for safe alternatives to risk choices, are not so much loss/gain as psychological inertia. Asymmetry. … [Sources: 1, 11, 12]

— Slimane Zouggari


##### Sources #####

[0]: https://blogs.scientificamerican.com/observations/why-the-most-important-idea-in-behavioral-decision-making-is-a-fallacy/

[1]: https://www.frontiersin.org/articles/10.3389/fpsyg.2019.02723/full

[2]: https://www.economicshelp.org/blog/glossary/loss-aversion/

[3]: https://www.hartfordfunds.com/insights/investor-insight/risk-aversion-vs-loss-aversion.html

[4]: https://www.behavioraleconomics.com/resources/mini-encyclopedia-of-be/loss-aversion/

[5]: https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/loss-aversion/

[6]: https://www.schwabassetmanagement.com/content/loss-aversion-bias

[7]: https://uxdesign.cc/cognitive-biases-loss-aversion-925149360f46

[8]: https://www.adcocksolutions.com/post/what-is-loss-aversion-bias

[9]: https://www.apa.org/science/about/psa/2015/01/gains-losses

[10]: https://thedecisionlab.com/biases/loss-aversion/

[11]: https://www.psychologytoday.com/us/blog/science-choice/201803/what-is-loss-aversion

[12]: https://en.wikipedia.org/wiki/Loss_aversion

[13]: https://www.miraeassetmf.co.in/knowledge-center/loss-aversion-bias

[14]: https://www.interaction-design.org/literature/topics/loss-aversion

[15]: https://ethicsunwrapped.utexas.edu/video/loss-aversion

[16]: https://www.investopedia.com/terms/l/loss-psychology.asp

[17]: https://www.emerald.com/insight/content/doi/10.1108/JEFAS-07-2017-0081/full/html