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What is loss aversion?

WELCOME! We are invited to play a famous TV money game.

To play, we have the choice between several lotteries:

Lottery 1: We have a 50% chance of winning €100 or winning nothing.
Lottery 2: We lose €100 or win €300 with a 50% chance.

What do we choose?

And now?

Lottery 1: We lose €100 or win nothing with a 50% chance.
Lottery 2: We win €100 or lose €300 with a 50% chance.

Most people choose Lottery 1 in the first scenario and Lottery 2 in the second scenario, even though their expected value is the smallest in both cases.

In the first scenario, we have:

  • Lottery 1 has an expected value of €50
  • Lottery 2 has an expected value of €100

In the second scenario, we have:

  • Lottery 1 has an expected value of – €50
  • Lottery 2 has an expected value of – €100

In economics and decision theory, loss aversion refers to the tendency to strongly prefer avoiding losses to acquiring gains. Some studies suggest that losses are twice as powerful, psychologically, as gains. Loss aversion was first convincingly demonstrated by Amos Tversky and Daniel Kahneman in their Prospect Theory.https://www.youtube.com/embed/rvozEnQunOA

For further information:

Tversky, A. & Kahneman, D. (1991). Loss Aversion in Riskless Choice: A Reference Dependent Model. Quarterly Journal of Economics 106, 1039-10 index

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