1. Varieties of Loss Aversion Lyle Brenner University of Florida Collaborators: Baler Bilgin Yuval Rottenstreich Sanjay Sood

2. What is Loss Aversion?  Initially, a component of the prospect theory value function

3. Loss Aversion in Risky Choice  Loss aversion explains why the following gambles are generally unattractive: 50% chance to win $X and 50% chance to lose $X w(.5) v(+X) + w(.5) v(-X) < 0 or: |v(-X)| > v(+X)  Losing $X is more unpleasant that getting $X is pleasant  “Losses loom larger than gains”  Loss sensitivity rather than loss aversion?

4. Applications: (Myopic) Loss Aversion  Can explain excessively timid choices in individual gambles, when a collection of repeated gambles would seem attractive (Kahneman & Lovallo, 1994)  Can explain why stocks are historically undervalued relative to bonds (Benartzi & Thaler, 1995)

5. Loss Aversion in Riskless Choice: Endowment Effect  Loss aversion principle generalizes beyond realm of gambles Mug experiment (Kahneman, Knetsch & Thaler, 1992)  Sellers: Mug worth $7.12 to those endowed with mug  Buyers: Mug worth $2.87 to those not endowed with mug  Choosers: indifferent between mug and $3.12 Conclusion: |v(lose mug)| > v(get mug)

6. Competing intuitions on staying vs. switching  Endowment effect (EE): tendency to stay with what you’ve got; overly value your possessions  Grass is greener (GG): tendency to switch to something else; overly value what you don’t have

7. How to define losses and gains?  How to interpret “Losses loom larger than gains”?  Ambiguity in definition of losses and gains

8. Defining loss and gain in terms of valence  Valence Loss: Something bad happens  Valence Gain: Something good happens Valence Loss Aversion (VLA):  Valence losses loom larger than valence gains  unpleasant changes are more extreme than “equivalent” pleasant changes

9. Defining loss and gain in terms of possession  Possession Loss: Something leaves your possession  Possession Gain: Something comes into your possession Possession Loss Aversion (PLA):  Possession losses loom larger than possession gains

10. Endowment Effect: PLA, VLA, or both Why is giving up a mug worse than getting a mug is pleasurable?  VLA: giving up mug is a big deal because it’s negative (rather than positive)  PLA: giving up mug is a big deal because it involves giving up (rather than receiving)

11. Relationship between Valence and Possession Changes Possession Change Possession GainPossession Loss Valence Change Valence Gain Valence Loss

12. Relationship between Valence and Possession Changes: Goods Possession Change Possession GainPossession Loss Valence Change Valence Gain Valence Loss With “Goods”, possession gain/loss and valence gain/loss are confounded (positively) Receive Mug Give up Mug

13. Relationship between Valence and Possession Changes: Bads Possession Change Possession GainPossession Loss Valence Change Valence Gain Valence Loss With “Bads”, possession gain/loss and valence gain/loss are confounded (negatively) “Receive” nausea “Give up” nausea

14. Stay or Switch Predictions: Goods Goods: Have +X, can switch to +Y  VLA  stay with +X –(because negatives of giving up +X loom larger than positives of getting +Y)  PLA  stay with +X – (because giving up +X looms larger than getting +Y)  Both VLA and PLA predict a tendency to stay  endowment effect

15. Stay or Switch Predictions: Bads Bads: Have -X, can switch to -Y  VLA  stay with -X –(because negatives of getting -Y loom larger than positives of giving up -X)  PLA  switch to -Y –(because giving up -X looms larger than getting -Y)  VLA predicts staying  endowment effect;  PLA predicts switching  grass is greener effect  Or if both VLA and PLA occur, then they push in opposite directions

16. Problem 1B Imagine that while driving to school one day, you’re caught going 45 mph in a 30 mph zone and given a speeding ticket. The penalty for the ticket is a fine of $100. A few days later, you receive a letter offering you the option of switching penalties. In particular, you may attend 3 three-hour sessions of traffic school instead of paying the fine of $100. Choice: Stay with fine, or switch to traffic school?

17. Problems 1G and 1B: Results Goods, Radio station call-in prize: $100, or free Jetski rental  Cash default: 83% stay  Jetski default: 30% stay  STAYSUM = 113% > 100% (endowment effect) Bads, Speeding penalties: $100 fine, or traffic school  Fine default: 12% stay  Traffic school default: 70% stay  STAYSUM = 82% < 100% (grass is greener effect)

18. Problems 2G and 2B: Results Goods, Jobs: More money, or more vacation days  $$ default: 59% stay  Vacation Days default: 65% stay  STAYSUM = 124% > 100% (endowment effect) Bads, Jobs: Long commute, or work weekends  Commute default: 52% stay  Work weekends default: 24% stay  STAYSUM = 76% < 100% (grass is greener effect)

19. Problems 3G and 3B: Results Goods, Apartments: Spacious, or great location  Spacious default: 71% stay  Location default: 44% stay  STAYSUM = 115% > 100% (endowment effect) Bads, Apartments: Noisy, or cramped  Noisy default: 66% stay  Cramped default: 39% stay  STAYSUM = 105% ~= 100% (no effect)

20. |VL|>VG PL>PG |VL|<VG PL<PG EE+, EE-, EE+ > EE- EE+, GG-, EE+ > GG- EE+, EE-, EE- > EE+ GG+, EE-, EE+ > EE- GG+, EE-, GG+ > EE- GG+, GG-, GG+ > GG- GG+, GG-, GG- > GG+ EE+, GG-, GG- > EE+ EE+ GG+ GG- EE- 3 2 1

21. Ratings: Getting and giving up bads Valence Loss & Possession Gain:  Imagine that you wake up one day with a really bad zit right on the tip of your nose. How unhappy would you feel about getting the zit? Valence Gain & Possession Loss:  Imagine that you wake up one day, and a really bad zit that used to be on the tip of your nose has disappeared! How happy would you feel about the zit going away?

22. Ratings: Getting and giving up bads  Get zit: unhappy rating 6.0 (on 1-9 scale)  Lose zit: happy rating: 6.5  Get side effects: unhappy rating 6.1  Lose side effects: happy rating: 6.9

23. Still more flavors of loss aversion Defining “loom larger”:  Looming as valuation (intensity of feeling): –Losses feel worse than gains feel good  Looming as attention/salience: –Losses dominate attention more than gains

24. Hotel Choice Golden Palms: Better condition, worse location Ocean View: Better location, worse condition

25. Hotel Choice Golden Palms: Better condition, worse location Ocean View: Better location, worse condition

26. Hotel Choice: Mediation/decomposition of endowment effect

27. Summary  Different definitions of losses & gains  different flavors of loss aversion (PLA & VLA) –Patterns of EE and GG effects: Evidence for PLA in addition to (or in place of) VLA  Different definitions of “loom larger”  different flavors of loss aversion –Evidence for both attentional and valuation components