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Concept
Loss aversion
Summary
Loss aversion is a psychological and economic concept which refers to how outcomes are interpreted as gains and losses where losses are subject to more sensitivity in people's responses compared to equivalent gains acquired. Kahneman and Tversky (1992) have suggested that losses can be twice as powerful, psychologically, as gains. When defined in terms of the utility function shape as in the Cumulative Prospect Theory (CPT), losses have a steeper utility than gains, thus being more "painful" than the satisfaction from a comparable gain as shown in Figure 1. Loss aversion was first proposed by Amos Tversky and Daniel Kahneman as an important framework for Prospect Theory - an analysis of decision under risk.
Finance and insurance are the sub fields of economics with the most active applications.
In 1979, Daniel Kahneman and his associate Amos Tversky originally coined the term loss aversion in their paper criticising the expected utility theory and proposing prospect theory as an alternative descriptive model of decision making under risk. “The response to losses is stronger than the response to corresponding gains” is Kahneman’s definition of loss aversion. “Losses loom larger than gains” implies that people by nature are aversive to losses and tend to avoid them. For example, given a choice between Option A: 50% chance of winning 1,000 Israeli pounds and 50% chance of winning nothing and Option B: winning 450 Israeli pounds for sure, the studied respondents were more likely to choose option B despite the higher expected value of option A (500 pounds). Loss aversion gets stronger as the stakes of a gamble or choice grow larger. Prospect theory and utility theory follow to make the person regret and feel anticipated disappointment for that said gamble.
After the first 1979 proposal in the prospect theory framework paper, Tversky and Kahneman also used loss aversion for a paper in 1991 about a consumer choice theory that incorporates reference dependence, loss aversion, and diminishing sensitivity.
Official source
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