Loss Aversion

What is it?

Loss aversion is a concept that stemmed from prospect theory and is encapsulated in the expression “losses loom larger than gains” (Kahneman & Tversky, 1979). Loss aversion refers to people's tendency to prefer avoiding losses to acquiring gains of equal magnitude. In other words, the value people place on avoiding a certain loss is higher than the value of acquiring a gain of equal size. 

It is thought that the pain of losing is psychologically about twice as powerful as the pleasure of gaining. People are more willing to take risks (or behave dishonestly; e.g. Schindler & Pfattheicher, 2016) to avoid a loss than to make a gain. The aversive response reflects the critical role of negative emotions (anxiety and fear) to losses (Rick, 2011).

Loss aversion has been used to explain the endowment effect and the sunk cost fallacy, and it may also play a role in the status quo bias.

Why is this theory important for behaviour change?

The basic principle of loss aversion can explain why penalty frames are sometimes more effective than reward frames in motivating people (Gächter et al., 2009) and has been applied in behaviour change strategies.

The idea suggests that people have a tendency to stick with what they have unless there is a good reason to switch. The loss aversion makes people resistant to change.  So when we think about change we focus more on what we might lose rather than on what we might get. Loss aversion predicts that people will follow conservative strategies when presented with a positively-framed dilemma, and risky strategies when presented with negatively-framed ones.

 

How could you apply this theory?

Emotion regulation, such as taking a different perspective, can reduce loss aversion and help people overcome potentially disadvantageous decision biases.

When analysing behaviours and their motivations/barriers, keep in mind that a losses loom larger than a gain. Don't just focus on the positive outcomes that an individual could gain but also address their potential losses.

Example of theory applied

  • From July 1981 to July 1983, a 10 percent increase in the price of eggs led to a 7.8 percent decrease in demand, whereas a 10 percent decrease in the price led to a 3.3 percent increase in demand (Putler, 1992).

  • Consider the so called Asian Disease Problem with which Kahneman and Tversky confronted participants in an experiment. In this problem, participants were told about a hypothetical outbreak of an unusual Asian disease threatening to kill 600 people in the United States. Participants had to choose between two alternatives to counteract this disease. One alternative was risky, saving all 600 people with a probability of one-third but otherwise all 600 people would be killed. In the other alternative, 200 people were saved and 400 were killed. If this problem was presented in a gain frame by mentioning how many lives in each alternative could be saved, most participants avoided risk and opted for the certain option. But if the problem was presented in a loss frame by mentioning how many people could die in each alternative, participants opted for the risky alternative. This puzzling result can be explained by loss aversion. The higher value of avoiding losses compared with gains makes the one-third probability of nobody getting killed much more attractive in the loss frame than it is in the gain frame (framed as saving 600 lives). Consistent with the assumptions of the prospect theory, people seem to avoid risk in gain frames while seeking risk in loss frames.