CONGRATULATIONS! We are invited to play a famous TV money game.
To play, we have the choice between several lotteries:
Lottery 1: We win €100 with a 50% chance and winning nothing.
Lottery 2: We lose €100 with a 50% of chance of winning €300.
What do we choose?
Lottery 1: We lose €100 with a 50% chance of winning nothing.
Lottery 2: We win €100 with a 50% chance of losing €300.
Most people choose Lottery 1 in the first scenario and Lottery 2 in the second scenario, while their expected value is the smallest in both cases.
In the first scenario, we have:
- Lottery 1 has an expected value of €50
- Lottery 2 has an expected value of €100
In the second scenario, we have:
- Lottery 1 has an expected value of – €50
- Lottery 2 has an expected value of – €100
In economics and decision theory, loss aversion refers to the tendency to strongly prefer avoiding losses to acquiring gains. Some studies suggest that losses are twice as powerful, psychologically, as gains. Loss aversion was first convincingly demonstrated by Amos Tversky and Daniel Kahneman in their Prospect Theory.
For further information:
Tversky, A. & Kahneman, D. (1991). Loss Aversion in Riskless Choice: A Reference Dependent Model. Quarterly Journal of Economics 106, 1039-10 index