Is loss aversion is a cognitive bias?
Money can be a useful tool for measuring people’s preferences. Our society is built around the concept of assigning value to different goods with money. Theories often require some form of measure, and money is often used as one of these measures in economics tests. To see if an individual has a general preference for avoiding loss or gaining more goods that have value, sometimes academics will use behavioral experiments that have little real-world application, but are simple enough to isolate the exact factor they want to test (in this case it would be whether the individual would choose to avoid or acquire monetary gains/losses).
1) Individual effects
Stocks and Commodities magazine suggests “A pertinent illustration might involve holding $50 in your hand while someone offers to buy it from you or, alternatively, sell you $50 for a lower price.” If the individual takes the initial offer (to purchase the $50 for more than its face value) then they are avoiding loss; if they choose to not take the initial offer and only participate in the second deal (receive less than $50), then they are choosing acquisition. According to this reasoning, an individual who prefers avoiding loss would have to have at least something of monetary value in their hand that can be taken away by another person without anything being given back in return.
2) Systemic effects
The systemic effect of loss aversion is small when both individuals involved are consumers, but when dealing with money on a larger scale it becomes clear how systemic loss aversion can have huge effects. This systemic effect is illustrated when looking at wealth distribution in the economic system. Some individuals are able to acquire more because they are willing to take risks that others are not, while some cannot acquire any capital because they are unwilling to take risks. Wealth begets wealth, and this is often referred to as the ‘Matthew Effect.’3 This implies that those individuals who invest their money into opportunities that have higher returns will be rewarded with more money than someone else who doesn’t make these investments.
3) Socio-economic factors
Individuals perceive losses differently depending on their socio-economical backgrounds. Approaches taken in behavioral experiments may rely heavily on framing effects or statistical significance in order for an individual’s bias to show. Cultural effects may affect the way an individual behaves in these experiments, or may even lead them astray. Individual preferences are heavily influenced by local society and culture, so someone from a developing country might be more likely to choose acquisition over loss avoiding behavior than someone living in Europe who is more likely to take the initial offer of $50.
4) Individual vs systemic effects
Loss aversion can have both individual and systemic effects on economies, but it’s important to understand that many economic theories only account for one or neither of these two effects. Loss aversion can also act as a driving force behind why people make certain decisions. Although experiments like this explain men’s choices (since it was conducted with male participants), loss aversion applies to all genders and races.
READ MORE:
http://www-personal.umich.edu/~bcalabresi/papers/Loss%20aversion.pdf
