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The loss aversion is almost trivially explained by the marginal value theorem. The subjective value of money is around log(money), that is, a meaningful change

by epx 8y ago

The loss aversion is almost trivially explained by the marginal value theorem. The subjective value of money is around log(money), that is, a meaningful change takes an extra 0 in the paycheck or in the price tag. So, if you have $200, getting $100 one thing, losing $100 is way worse, since log(200)=2.30, log(200)-log(100)=0.3, log(300)-log(200)=0.18. A potential loss of $100 must be rewarded by a gain of $200 to "feel" worthwhile if you already have $200, since log(400)-log(200)=log(200)-log(100).

kashyapc 8y ago
Something along those lines is what I recall reading in Kahneman's book. I just double-checked the 'Loss Aversion' chapter, and indeed he writes, and elaborates further: "What is the smallest gain that I need to balance an equal chance to lose $100? For many people the answer is about $200, twice as much as the loss. The "loss aversion ratio" has been estimated in several experiments and is usually in the range of 1.5 to 2.5. This is an average, of course; some people are much more loss averse than others. Professional risk takers in the financial markets are more tolerant of losses, probably because they do not respond emotionally to every fluctuation. When participants in an experiment were instructed to "think like a trader," they became less loss averse and their emotional reaction to losses (measured by a physiological index of emotional arousal) was sharply reduced. [...]"
- mrob 8y ago
  >Professional risk takers in the financial markets are more tolerant of losses, probably because they do not respond emotionally to every fluctuation. Or more plausibly, because they're richer, and the utility they stand to lose is smaller.
  - kashyapc 8y ago
    Good reminder. Although subconsciously I realize that, I didn't remind myself that way and after re-reading that paragraph, I thought: "hmm, maybe I should up 'risk-seeking' dial a bit more"—which can be evaluated independently, though, depending on one's "risk profile".
brewmarche 8y ago
I don’t think that’s true. Marginal utility can explain the directional component but not the reference point component. Let’s take the example from the comment above. A car salesman gets $100 in the morning and has to give it back in the evening if he doesn’t sell enough cars. Compare that to just handing out $100 if he’s successful in the evening. From an expected utility view both of these arrangements are equivalent. Loss aversion argues that they’re not, because the salesman’s reference point for loss/gain shifts after obtaining ownership of the $100.
Izkata 8y ago
Another experiment with similar results, that humans naturally think logarithmically: http://news.mit.edu/2012/thinking-logarithmically-1005 http://news.mit.edu/2012/thinking-logarithmically-1005

by epx 8y ago

kashyapc 8y ago

Something along those lines is what I recall reading in Kahneman's book. I just double-checked the 'Loss Aversion' chapter, and indeed he writes, and elaborates further: "What is the smallest gain that I need to balance an equal chance to lose $100? For many people the answer is about $200, twice as much as the loss. The "loss aversion ratio" has been estimated in several experiments and is usually in the range of 1.5 to 2.5. This is an average, of course; some people are much more loss averse than others. Professional risk takers in the financial markets are more tolerant of losses, probably because they do not respond emotionally to every fluctuation. When participants in an experiment were instructed to "think like a trader," they became less loss averse and their emotional reaction to losses (measured by a physiological index of emotional arousal) was sharply reduced. [...]"

mrob 8y ago
>Professional risk takers in the financial markets are more tolerant of losses, probably because they do not respond emotionally to every fluctuation. Or more plausibly, because they're richer, and the utility they stand to lose is smaller.
- kashyapc 8y ago
  Good reminder. Although subconsciously I realize that, I didn't remind myself that way and after re-reading that paragraph, I thought: "hmm, maybe I should up 'risk-seeking' dial a bit more"—which can be evaluated independently, though, depending on one's "risk profile".

brewmarche 8y ago

I don’t think that’s true. Marginal utility can explain the directional component but not the reference point component. Let’s take the example from the comment above. A car salesman gets $100 in the morning and has to give it back in the evening if he doesn’t sell enough cars. Compare that to just handing out $100 if he’s successful in the evening. From an expected utility view both of these arrangements are equivalent. Loss aversion argues that they’re not, because the salesman’s reference point for loss/gain shifts after obtaining ownership of the $100.

Izkata 8y ago

Another experiment with similar results, that humans naturally think logarithmically: http://news.mit.edu/2012/thinking-logarithmically-1005 http://news.mit.edu/2012/thinking-logarithmically-1005