Loss Aversion

Loss aversion is a widespread behavioural trait which causes people to experience the suffering from a loss much more deeply than the joy from a commensurate gain

Loss Aversion

Background

Everyone knows that people don’t like to lose things.

People are reluctant to give their old clothes to Vinnies, to leave dysfunctional relationships, or to throw away an old pair of slippers.

While it is common sense that people are averse to loss, the principle of “loss aversion” is a relatively new development in the history of economic thought. It was first introduced by Danny Kahneman and the late Amos Tversky in 1979 to help them explain how people make decisions under conditions of risk.

What is Loss Aversion?

Loss aversion is a widespread behavioural trait which causes people to experience the suffering from a loss much more deeply than the joy from a commensurate gain.

The emotional impact from a loss is thought to be around twice that of a comparable gain. Or, as Dan Ariely puts it, “finding $100 feels pretty good, whereas losing $100 is absolutely miserable.”

While prevalent in humans, loss aversion is by no means unique to homo sapiens. In a study conducted around 2005, capuchin monkeys were shown to exhibit similar behaviour.

Under experimental conditions, the capuchins were offered two alternative gambles: (i) one grape with a coin-flip chance of winning a second grape, or (ii) two grapes with a coin-flip chance of losing the second grape.

As you will appreciate, the two gambles offer the same sweetener (in expectation). The only difference was that the first gamble was framed as a potential win, whereas the second was framed as a potential loss.

Which alternative did the monkeys prefer? Surprisingly, they favoured the first one, the gamble framed as a potential win.

This is not what mainstream economics would predict. But, as it turns out, the capuchin monkeys share a certain behavioural trait with most humans – loss aversion.

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