Loss aversion once again

Starting the new year with increased uncertainty

Behavioral New World

January 1, 2025

Starting the new year with increased uncertainty

I have written two newsletters on the concept of loss aversion. The first (link) introduces the idea and the second (link) reports that even monkeys’ behavior appears consistent with loss aversion. Daniel Kahneman, grandfather of behavioral economics and Nobel prize winner, has written, “…the concept of loss aversion is certainly the most significant contribution of psychology to behavioral economics.”[1]

A quick recap: Loss aversion is the tendency for us humans to have a greater sensitivity to losses than gains. That is, losses inflict greater pain than equivalent gains provide pleasure.

But in the spirit of intellectual inquiry (and humility) as well as an effort to avoid my own confirmation bias (link), this newsletter discusses the contrary view that loss aversion is not important, perhaps non-existent.

Some evidence suggesting that loss aversion is a fallacy comes from research on consumer behavior. One study (described here) reports that:

Contrary to claims based on loss aversion, price increases (ie, losses for consumers) do not impact consumer behavior more than price decreases (ie, gains for consumers). Messages that frame an appeal in terms of a loss (eg, “you will lose out by not buying our product”) are no more persuasive than messages that frame an appeal in terms of a gain (eg, “you will gain by buying our product”).

Other evidence comes from neuroscience. A brain scan study (link) found that most people respond more emotionally to gains rather than losses, contrary to what we might expect from loss aversion.

Can the evidence that supports loss aversion be explained in other ways? That is, if not loss aversion, then what?

Framing. Consider asking people about whether they would undergo a medical procedure. Some people are told about the success rate of the procedure and some about the failure rate. These presentations provide the same information because a lack of success is a failure. Yet people are more likely to choose the procedure when presented with the success rate.[2] One interpretation is that this evidence supports loss aversion. But it might just be a framing effect coupled with cognitive limitations (see next).

Complexity. A blog post (link) describes a recent study (link) that reports evidence that complex settings are associated with decisions that look like loss aversion even in the absence of uncertainty (such as the uncertainty of the medical procedure). That is, loss aversion is not needed to explain seemingly irrational—or at least suboptimal—decisions.

The potential non-existence of loss aversion (or at least attenuated existence) is important for a variety of reasons, but perhaps none more so than the fact that it has shaped the way incentives are constructed. For example, as suggested above, pricing decisions sometimes rely on the loss aversion of consumers.

Another example: Some school districts assign points to students at the beginning of the term that can be taken away for, say, missed assignments. The loss of points is presumed to be sufficiently hurtful that students will miss few assignments.

In light of the recent evidence cited above, can we reject the concept of loss aversion? I think not, but our thinking must become more nuanced. Many studies have documented loss aversion; however, it might be less important in some circumstances. As discussed above, it seems not to be important in the pricing of consumer goods.

Its effect is likely to be weak in small-stakes settings—think penny-ante poker. In some circumstances, loss aversion might be muted by framing or other effects. Time pressure leads to riskier decisions, suggesting less loss aversion in such situations (link). The degree of loss aversion seems to vary with culture (link).

So you went to bed last night (or early this morning) thinking that loss aversion was a part of the bedrock of behavioral economics. Well, maybe that’s not what you were thinking when you went to bed on New Year’s Eve. Regardless though, you wake up this morning to find that loss aversion might not be as ubiquitous as you thought.

A greater awareness of where it is likely to be important and where not makes for better decisions. Better decision-making sounds like a good New Year’s resolution to me!

I’d love to hear examples—in the Comments below—of incentive structures that seem to be constructed with loss aversion in mind. More generally, what is your opinion of, or experience with, loss aversion?

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[1] Daniel Kahneman, 2011, Thinking, Fast and Slow, p. 341, Macmillan.

[2] Thinking, Fast and Slow, Chapter 34.