Reference dependence and lottery participation

Probability weighting and loss aversion in futures hedging

The purpose of this paper is to verify that discrete statistical distributions of the US stock market are consistent with loss aversion. Loss aversion has the following tenets: an S-shaped valuation function, characterized by diminishing sensitivity, a loss aversion coefficient higher than +1, probability weighting, and reference-dependence. Diminishing sensitivity implies that the exponent of the valuation function is between 0 and +1. It is expected that this exponent be higher for losses. Probability weighting replaces objective with subjective probabilities. Loss aversion is indicated by a coefficient higher than +1 for the valuation of losses. There are three parameters: the two exponents of the valuation function, and the loss aversion coefficient. There is one non-linear equation: the certainty equivalence relation. The procedure is to fix two parameters and find the third parameter by solving the non-linear certainty equivalence equation, using the EXCEL spreadsheet. The program is repeated for more than one case about the fixed parameters, and by enriching the analysis with probability weighting. The calibrations executed point strongly to the conclusion that loss aversion is consistent with six discrete distributions of the first two moments of returns of the US stock markets. The calibration process provides for reasonable estimates of the key parameters of loss aversion. These estimates suggest a more pronounced diminishing sensitivity, and a higher than expected coefficient of loss aversion, especially when probability weighting is imposed.

Prospect theory introduces several anomalies in the behavior of rational agents, including loss aversion, the reflection effect, probability weighting, and the certainty effect. Loss aversion occurs relative to the current state of the world, called reference point. Being loss averse causes people to prefer the current state of affairs above and beyond the expected utility that comes from a risky political change, engendering a status quo bias. Yet, bias is asymmetric due to the reflection effect: people are too tepid toward advantageous platforms or candidates, whereas they are not critical enough of detrimental policies or bad politicians. Both rich and poor citizens take similar stances on nonpartisan issues (such as national defense): this happens because they evaluate uncertain policy changes relative to a reference point. Citizens welcome radical political platforms with greater enthusiasm than incremental proposals. Generally, under prospect theory societal conflict is smoother than under expected utility theory. Older societies are more prone to preserving the status quo than younger ones. These properties also affect the choice of voting rules. Loss aversion induces people to prefer more prudent voting rules and preserve the status quo. Hence, agents favor higher majority thresholds or even unanimity over simple majority in constitutional choice. The status quo bias supports the persistence of policy cycles, with prolonged drifts in one direction before a trend reversal. In sum, loss aversion and other anomalies pinpointed by prospect theory offer insightful predictions with which to study political phenomena.

We suggest that, beside the classical endowment and disappointment effects, also envy can be modeled as Kahneman-Tversky loss aversion in a reference-dependent preference framework. In a risk-free setting especially suited to test for envy, a decomposition of referencedependent utility into basic utility and a disappointment evaluation function is achieved, where basic utility is recovered by diagonalization. This feature sets our approach apart from disappointment theories of Sugden (JET 2003) and Bleichrodt (JMP 2009). Empirical evidences on the ultimatum game confirm this model and shows the presence of both inequality aversion on one’s disadvantage (envy), and on one’s advantage (Bellamare et al. Econometrica 2008). We propose a common measure of loss aversion and envy for reference dependent preferences, which generalizes the index of Kobberling and Wakker (JET 2005). The class of constant loss aversion/envy coincides with that of Kahneman and Tversky. We show that Arrow-Pratt absolute risk aversion increases by the relative marginal loss aversion. This inspires further tests of the loss aversion theory of envy.

Loss aversion behavior plays a major role in the pricing of commercial properties, and it varies both across the type of market participants and across the cycle. We find that sophisticated and more experienced investors are at least as loss averse as their counterparts and that loss aversion operated most strongly during the cycle peak in 2007. We also document a possible anchoring effect of the asking price in influencing buyer valuation and subsequent transaction price. We demonstrate the importance of behavioral phenomena in constructing hedonic price indices, and we find that the impact of loss aversion is attenuated at the aggregate market level. This suggests that the pricing and volume cycle during 2001–2009 was little affected by loss aversion.

The attention–aversion gap: how allocation of attention relates to loss aversion

Empirical Evidence of Loss Aversion and Individualism Around the World

We examine the effects of reference income on the behavior of young male physicians. Using a unique panel of data, we relate physicians' reference and actual incomes to their subsequent income growth. Reference income has a strong positive effect on subsequent income for physicians who are below their reference points, but not for physicians who are at or above their reference points. Loss aversion, which posits a kink in utility at the reference point, explains this puzzling pattern. Physicians respond strongly to shortfalls from the reference point—they take unappealing actions to boost earnings—because the marginal utility of income is steep in that range. Competing prominent theories, tested here, fail to explain these relationships.

Loss aversion around the world: Empirical evidence from pension funds

Towards a Purely Behavioral Definition of Loss Aversion

Experience of losses and aversion to uncertainty - experimental evidence from farmers in Mexico

Is it All Connected? A Testing Ground for Unified Theories of Behavioral Economics Phenomena

Loss Aversion, Intellectual Inertia, and a Call for a More Contrarian Science: A Reply to Simonson & Kivetz and Higgins & Liberman

Loss Aversion and Anchoring in Commercial Real Estate Pricing: Empirical Evidence and Price Index Implications

Online reputational loss aversion: Empirical evidence from StackOverflow.com