13. Loss Aversion
What Is Loss Aversion?
Loss aversion is the tendency for people to perceive potential losses as more significant or consequential than potential gains of the same objective magnitude (Kahneman & Tversky, 1979).
When making decisions under uncertainty (which is most of the time!), we consider the possible outcomes of our choices. Even though we may hope for the best, we pay more attention to and put more weight on possible negative results than positive ones. We are loss “averse” — our decision-making process is biased towards preventing losses compared to seeking gains.
Example: Wedding dress
Remember that wedding dress you could sell for hundreds of dollars still hanging in your closet?
In this case, the loss of the dress (which objectively has no current utility) is viewed as more significant than the gain of the money and closet space! (which objectively do have current utility).
Loss Aversion & Status Quo Bias
Loss aversion has been linked with the status quo bias — we may choose to stick with what we know or have done in the past when an alternative choice involves both gains and losses (Fernandez & Rodrik, 1991). By following the status quo bias, we avoid the potential of expected losses (and the gains, too, of course, but as discussed, those are less appreciated than the losses). This is also illustrated in the example above — both loss aversion and status quo may affect our decision to keep holding on to the dress in this scenario.
Notably, as with most of these biases, loss aversion is not necessarily present for every person in every situation, and research has shown that our susceptibility to this bias may vary based on individual differences as well as contextual factors (e.g. Rakow et al., 2020). Many people do sell their wedding dresses! 😊
The following video explains Kahneman and Tversky’s (1979) prospect theory and gives more examples of loss aversion.
Video Link: Prospect Theory (explained in a minute) – Behavioural Finance [1:36 min] by Sanlam Investments (2016).
