Loss Aversion Behavior Research Articles

Loss Aversion and Tax Evasion: Theory and Evidence

We consider income-source-dependent tax evasion and show that this is a generalisation of the well-known endowment effect. We show that loss aversion, moral costs, mental accounting and risk preferences play a role in explaining key features of source-dependent tax evasion. We provide evidence of the first direct link between subject-specific loss aversion and tax evasion, which is central to most successful modern theoretical accounts of tax evasion. We provide some evidence that risk aversion strengthens the cautionary effect of loss aversion and risk loving behaviour attenuates, or reverses, it. However, the underlying effect is also influenced by the source of income. Evasion is increasing in the tax rate and decreasing in the audit penalty, as predicted. Our study provides novel theoretical insights; proposes new methods in the estimation of the underlying behavioural parameters; and confirms the central predictions of the theory, while pointing out challenges for further developments that existing theory is unable to account for. JEL: C91, C92, D82, D91, G21

Asymmetric dependence between the prospect theory value and stock returns in India: a quantile regression approach

PurposeMotivated by the evidence highlighting the role of sentiments and cognitive biases in investors' decision-making, this study examines a novel behavioral finance-based asset pricing model incorporating the prospect theory framework in the Indian equity market. Specifically, the study’s primary objective is to investigate the importance of Prospect Theory Value (PTV) in the cross-sectional pricing of stocks.Design/methodology/approachThe empirical findings rely on data taken from NIFTY 500 and BSE S&P 500 stocks, encompassing daily, weekly and monthly observations. The analysis employs diverse statistical techniques, including Ordinary Least Squares (OLS), Fama–Macbeth Cross-section Regressions, Panel Fixed Effect and Quantile Regression.FindingsThe study demonstrates an asymmetric association between PTV and subsequent stock returns. The findings maintain their robustness even when factoring in stock-specific attributes such as market capitalization and book-to-market ratio, market beta and indicators related to lottery-like behavior such as skewness and MAX. This observed pattern persists when analyzing data at various frequencies, including daily, weekly and monthly intervals. Loss aversion behavior dominates among Indian equity investors, contrary to lottery preferences in the US equity market.Originality/valueAs far as the authors are aware, the study is the first to introduce a new behavioral finance-motivated stock return predictor (PTV) in the Indian stock market. The study also marks the pioneering use of a novel method that evaluates the predictability of PTV across various sections of the conditional return distribution using quantile regression.

Supply, Demand and Asymmetric Adjustment of House Prices in Poland

Abstract In recent years, a lot of empirical effort has been made to search for potential nonlinear responses of house prices to various demand and supply factors. This paper examines Poland's heterogeneous regional housing market reactions to key economic variables from 2000 to 2022. The study raises two research questions related to the asymmetric adjustment of housing markets to selected demand and supply shocks. Firstly, we ask whether the house price adjustments to negative shocks are relatively minor (for example, during an economic downturn) when compared to positive shocks (prevalent in booming markets), mainly due to the loss aversion behavior theory and nominal rigidity of house prices. In particular, we test the hypothesis that house prices react more to positive impulses from supply and demand than negative ones. Secondly, we investigate whether market reactions are similar for large and small metropolitan markets. The second hypothesis posits that metropolitan housing markets adjust asymmetrically to demand and supply shocks based on the city size (population and housing stock in a given city). The study uses a nonlinear ARDL model to test the research hypotheses empirically. This paper provides new insights into the nonlinear reactions of house prices to exogenous shocks and adds to the limited empirical evidence from less developed economies.

CEO Current and Prospective Wealth Option Compensation and Corporate Social Responsibility: The Behavioral Agency Model

This study examines the relationship between CEO options compensation and corporate social responsibility (CSR) based on the behavioral agency model (BAM). The BAM assumes that the CEO is bounded by loss-aversion behavior. Using constructs from the BAM, i.e., CEO current and prospective wealth from their options compensation, this study examines the differing effects of CEO current wealth and prospective wealth on firms’ CSR strengths, CSR concerns, institutional CSR and technical CSR. Based on a sample of 1565 U.S. firms during 1996 to 2018, the study finds that CEO current wealth is negatively related to firms’ CSR strengths and CSR concerns. The study also finds that CEO prospective wealth is positively related to firms’ CSR strengths but is unrelated to CSR concerns. CEO current wealth is negatively related to institutional CSR, whereas CEO prospective wealth is positively related to institutional and technical CSR. CEO current (prospective) wealth is more strongly and negatively (positively) related to institutional CSR than technical CSR. This study indicates that designing CEO option compensation to align top managers’ interests with the stakeholder interests requires a greater understanding of how CEO bounded rationality behavior toward loss aversion and risk taking is influenced by their option compensation.

Sensitivity of Chinese stock markets to individual investor sentiment: An analysis of Sina Weibo mood related to COVID-19

This research explores the impact of individual investor sentiment derived from social networks on stock market returns. Using keyword-based techniques, we collect and analyze Sina Weibo posts related to COVID-19, extracting daily influential weighted sentiment indexes from a dataset of over 2.4 million posts in 2020. Empirical tests utilizing a sentiment-augmented three-factor model reveal that individual investor sentiment exerts an independent influence on Chinese financial markets, after controlling for market risk, size, and value effects. We further find that negative sentiment carries a stronger impact on stock returns, which is in line with the loss-averse behavior commonly observed among individual investors. We also find an asymmetric pattern in the sentiment-return relation across different industry types. While positive sentiment affects both types of industries that suffer or benefit from COVID-19, negative sentiment affects only the industries that suffer from the pandemic. Overall, our empirical results provide robust support for the significance of individual investor sentiment in explaining the behavior of the Chinese financial markets.

Toward an Information-Processing Theory of Loss Aversion

Imperfect information processing can lead to loss aversion behavior.

Research on Supply Chain Emission Reduction Decisions Considering Loss Aversion under the Influence of a Lag Effect

Considering that a lag effect exists in R&D investment, investigating the impacts of manufacturers’ resulting loss-averse behavior on R&D investment in carbon emission reduction technologies is important. This paper establishes three differential game models, namely centralized decision making, decentralized decision making with the manufacturers’ rational preferences, and decentralized decision making with the manufacturers’ loss-aversion preferences. The models are used to analyze the mechanism of the lag effect and loss aversion on manufacturers’ R&D investment in emission reduction, based on a two-level supply chain consisting of manufacturers and retailers. This study finds that: (1) The lag effect can encourage manufacturers to invest in the R&D of emission reduction technologies. (2) There is a threshold value for the lag time, and only when the lag time is higher than this threshold value will manufacturers display loss-averse behavior. (3) When manufacturers’ degree of loss aversion is small, loss-averse behavior has a negative effect on their investment in the R&D of emission reduction technologies, while the opposite has a positive effect.

Choices between adaptation and coping strategies as responses to cyclonic shocks and their impact on household welfare in villages on the east coast of India

Mitigation against climate extremes is not an option anymore but a necessity. Households maximize their utility with bounded rationality, yet there are gaps in the choices which make them poor and vulnerable. This is because of the loss aversion behavior toward adopting strategies. Tropical Cyclones Coping Strategies (TCCS) are ex-post short-term immediate strategies, which are preferred to Tropical Cyclones Adaptation Strategies (TCAS), which are ex-ante long-term strategies. These choices are intertemporal, and they impact the welfare of the households. We surveyed 504 households in 13 villages of Odisha state on the east coast of India, which are affected by recurrent cyclones. The multivariate probit model is applied to find the determinants affecting the choice of each TCAS and TCCS. After that, we quantify household welfare by using the endogenous switching probit model and its treatment effects. The results show that formal education, formal credit, and risk behavior are key determinants of TCAS and TCCS. Household welfare increases when households embark on various TCCS, but there does not seem to be any such benefit or loss from TCAS. However, there is welfare loss for those who haven't undertaken any strategy. We find that the behavior of the coastal households is loss aversive, where they discount the future more and value the present. Hence, they ignore adaptation strategies, assuming that coping strategies will adequately help them recover. We conclude that household behavior needs transformation, and policies and regulations should be inclined toward attracting long-term strategies more, with effective private and public interventions.

Predicting loss aversion behavior with machine-learning methods

This paper proposes to forecast an important cognitive phenomenon called the Loss Aversion Bias via Hybrid Machine Learning Models. One of the unique aspects of this study is using the reaction time (milliseconds), psychological factors (self-confidence scale, Beck’s hopelessness scale, loss-aversion), and personality traits (financial literacy scales, socio-demographic features) as features in classification and regression methods. We found that Random Forest was superior to other algorithms, and when the positive spread ratio (between gain and loss) converged to default loss aversion level, decision-makers minimize their decision duration while gambling, we named this phenomenon as “irresistible impulse of gambling”.

Dual-Channel Pricing Decisions for Product Recycling in Green Supply Chain Operations: Considering the Impact of Consumer Loss Aversion.

With the vigorous rise of online third-party recycling platforms, dual-channel recycling has become the primary recycling mode in the reverse supply chain (RSC). However, as the main body of recycling, consumers have a significant impact on the recycling process, and their behavioral preferences are rarely considered in the pricing decision of the reverse recycling supply chain. Based on the dual-channel RSC, this paper considers the competition among channels. It introduces the loss aversion behavior preference of consumers to establish a dual-channel RSC composed of remanufacturers and online and offline recyclers. This study aims to analyze the impact of consumers' loss aversion behavior on the recycling pricing and profit of each node in the green RSC and discuss the decision of recyclers under consumers' loss aversion behavior. The results show that the deeper consumers' aversion to the loss of recycling price, the lower the recycling price of dual-channel recyclers will be, which will be more conducive to the increase in the profit of online recyclers. However, the profit of remanufacturers will be reduced, and the total amount of recycling will decline. This paper considers the impact of consumer loss aversion behavior on dual-channel reverse supply chain pricing decisions based on prospect theory. It provides references for chain members to set recycling prices to increase people's enthusiasm for recycling and the amount of recycled scrap, contributes to the cause of resource conservation and environmental protection, and improves the economic efficiency of recycling enterprises.

An efficient multi-attribute multi-item auction mechanism with ex-ante and ex-post satisfaction for 4PL transportation service procurement

Reverse auction is an effective tool for a 4PL to purchase transportation services. This paper investigated a new transportation services procurement problem for 4PL, which involves three features: the 4PL’s loss-averse behavior, price and non-price attributes, and multiple transportation requests. An efficient multi-attribute multi-item reverse auction mechanism considering the 4PL ex-ante and ex-post satisfaction (EES-MMRA) is proposed to purchase transportation services for the 4PL. In the EES-MMRA, integrating the allocation rule with the 4PL ex-ante satisfaction, a 0-1 programming model is constructed to determine winning 3PLs and obtain efficient allocations. Then, a payment rule considering the 4PL ex-post satisfaction is established to ensure truthful bidding of 3PLs. And we discuss some desirable properties (e.g., incentive compatibility, individual rationality, efficiency, and budget balance properties) to justify the EES-MMRA mechanism, subsequently. Next, several numerical experiments are conducted to demonstrate the effectiveness and applicability of the EES-MMRA mechanism. Furthermore, sensitivity analysis presents the influences of the weights of the non-price attributes, risk attitude coefficients, and loss aversion coefficients. Finally, we conduct comparison analysis to show the advantages of the EES-MMRA mechanism over the known Vickrey–Clark–Groves (P-VCG) mechanism.

SYRIA AS A SHATTER BELT AND THE GREAT POWER COMPETITION

In geopolitics, the term ‘shatter belt’ refers to a region that is highly vulnerable to conflicts and is often an arena for great power competition through proxy wars. For more than a decade, Syria has been engaged in a similar unprecedented state of conflict involving domestic and foreign actors – a conflict that has exacerbated the dilapidated political, economic, and social security. As per the Fragile States Index 2021, Syria is one of the world's top three most fragile states, indicating its vulnerability and unsustainability. Using qualitative data through secondary sources, this paper highlights how Syria serves as a shatter belt for major powers, explicating interests of the US, Russia, Iran and Saudi Arabia. In order to understand the dynamics of conflict, the paper applies Amos Tversky’s Prospect theory which highlights stakeholders' loss aversion and risk-acceptant behaviour. In addition, the paper highlights that conflict resolution strategies applied to resolve the conflict have failed so far. In this regard, John Burton’s Human Needs theory is applied to the case study to emphasize what can be done to resolve this protracted conflict. Bibliography Entry Ashraf, Nageen. 2022. "Syria as a Shatter Belt and the Great Power Competition." Margalla Papers 26 (2): 28-38.

Blunted neuroeconomic loss aversion in schizophrenia

BackgroundAbnormal social decision-making is prominent in schizophrenia. Antipsychotic medication often improves interpersonal functioning but this action is poorly understood. Neuroeconomic paradigms are an effective method of investigating social decision-making in psychiatric disorders that can be adapted for use with neuroimaging. Using a neuroeconomic approach, it has been shown that healthy humans reproducibly alter their behavior in different contexts, including exhibiting loss aversion: a higher sensitivity to loss outcomes compared to gains of the same magnitude. MethodsHere, using a novel loss aversion task and fMRI, we tested three hypotheses: controls exhibiting normal behavioral loss aversion show changes in brain activity consistent with previous studies on healthy subjects; behavioral loss aversion is significantly reduced in schizophrenia and associated with abnormal activity in the same brain regions activated in controls during loss aversion behavior; and for the patient group alone, there is a significant correlation between increased psychotic symptoms, blunted loss aversion and abnormal brain activity. These hypotheses were tested in patients with schizophrenia and healthy controls using a loss aversion paradigm and fMRI. ResultsThe results support the hypotheses, with patients exhibiting significantly blunted behavioral loss aversion compared to controls. Controls showed a robust loss aversion brain activation pattern in the medial temporal lobe, insula and dopaminergic-linked areas, which was blunted in schizophrenia. ConclusionsOur results are consistent with blunted loss aversion being a reproducible feature of schizophrenia, likely due to abnormal dopaminergic and medial temporal lobe function, suggesting a route by which antipsychotics could influence interpersonal behavior.

The Effects of Behavioral Foundations and Business Strategy on Corporate Dividend Policy

This study analyzes the influence of behavioral foundation factors and corporate strategic behavior on the formulation of corporate dividend policy. We use the Logit model and the OLS model for estimating the empirical model. The year- and industry-fixed effects are controlled in the model. We consider the behavioral foundations in three dimensions-ambiguity aversions, risk aversion, and loss aversion. The results show firms with high ambiguity or high risk infrequently pay dividends but firms with loss-averse behavior tend to pay dividends. This paper also provides evidence that a firms’ business strategy influences its corporate dividend policy. Aggressive firms inhibit the payout of dividends. In additional tests, we find the results remain unchanged in those firms with high corporate governance or high growth opportunities.

The impacts of digital content piracy and copyright protection policies when consumers are loss averse

<p style='text-indent:20px;'>Recent technological advances in digitization and online communications have enabled unauthorized reproduction and illegal file-sharing. However, controversies still exist over the impacts of digital content piracy and copyright protection policies. Using a game-theoretic framework, we examine the impacts of digital content piracy and copyright protection policies on product quality, firm profitability, consumer surplus, and social welfare when consumers exhibit loss aversion in the quality dimension. Specifically, consumers are initially uncertain about the product quality and will form an expectation, but once they buy the licensed product or use piracy, they know the actual product quality and compare it with their expectation. When consumers are loss averse, consumer propensity to an option is more negatively affected by product quality above the expectation than positively affected by product quality below the expectation. Our analysis shows that although piracy exerts a negative cannibalization effect in the absence of loss aversion, it can exert an additional positive information effect when the degree of loss aversion on the licensed product is higher than the degree of loss aversion on piracy. We find that when the information effect dominates the cannibalization effect, piracy can lead to a win-win situation for firm profitability and consumer surplus. Moreover, under certain circumstances, anti-protection policies can simultaneously raise product quality, firm profitability and consumer surplus. The rationale behind the positive impacts of piracy and anti-protection policies is rooted in the influences of loss aversion behavior on consumer purchase decisions. The results show that it is essential to quantify the degree of consumer loss aversion for firms in formulating pricing and quality strategies and for policymakers to develop copyright protection policies.</p>

PENGUJIAN LOSS AVERSION INVESTOR DI BURSA EFEK INDONESIA (STUDI PADA PERUSAHAAN INDEKS KOMPAS100 YANG TERCATAT DI BURSA EFEK INDONESIA)

This study aims to examine the existence of loss aversion behavior bias or in practice it is called the disposition effect on Kompas100 Index companies listed on the Indonesian Stock Exchange. Testing of one of these bias of investor behavior was carried out for five years, from 2015 – 2019 period. This study uses data on holding period, illiquidity, and stock returns, as well as firm size proxied by market capitalization as a control variable. The behavioral bias that causes the disposition effect is indicated when illiquidity has a positive and significant effect on the holding period. Meanwhile, regret avoiding disposition effect is indicated if return has a negative and significant effect on the holding period. To see this effect, an analysis was carried out using multiple linear regression tests. The results showed that there was a disposition effect and regret avoiding disposition effect on Kompas100 Index companies listed on the Indonesia Stock Exchange.

Should the Loss-aversion Behavior be Significant for Central Bankers? Evidence from Behavioral Economics

This paper compares the effectiveness of the monetary policy based on conventional utility function and prospect theory. According to prospect theory, in the face of uncertainty, people make decisions based on perceived losses and benefits, so they are more sensitive to losses than to gains of equal size. Achieving this goal, we estimated the DSGE Model for the Iranian economy. The results of Bayesian estimation showed that under prospect theory, the inclusion of the loss-aversion component affects the household consumption behavior, the labor supply, and the real money demand. Also, The results of the Impulse-Response analysis show that an expansionary monetary shock led to an overestimate of inflation expectations due to fear of losses resulting from rising inflation. Hence, under the prospect theory, inflation increases relatively more, and the interest rate decreases with less intensity. Moreover, the more attention to the behavior of loss-aversion agents by policymakers, the less volatility is in macroeconomic variables.

The effect of testosterone on economic risk-taking: A multi-study, multi-method investigation

Testosterone has been suggested to influence individuals' economic decision making, yet the effects of testosterone on economic behavior are not well-understood and existing research is equivocal. In response, in three studies, we examined the extent to which testosterone affected or was associated with several different facets of economic decision making. Study 1 was a double-blind, placebo-controlled, within-subjects study examining loss aversion and risk-taking (N = 26), whereas Study 2 was a larger double-blind, placebo-controlled, between-subjects study examining loss aversion and risk-taking behavior (N = 117). As a methodological compliment, Study 3 was a larger correlational design (N = 213) with a highly accurate measure of endogenous testosterone examining a wider range of economic behaviors and trait-like preferences. Broadly, the results of all three studies suggest no consistent relationship between testosterone and financial behavior or preferences. Although there were significant effects in specific cases, these findings did not replicate in other studies or would not remain significant when controlling for family-wise error rate. We consider potential contextual moderators that may determine under what circumstances testosterone affects economic decision making.

The effect of brand loyalty and loss aversion on competitive trade-in strategies

Trade-in promotions allow consumers to turn in old products and receive a discount for purchasing a new item. Firms usually price discriminate consumers based on their purchase history (i.e. new or existing customers). However, behavioural research has shown that consumers exhibit loss aversion and brand loyalty after consuming a product that may influence economic outcomes. This paper examines the impact of consumers’ loss aversion and brand loyalty behaviour on firms’ trade-in promotion pricing strategy, profits, consumer surplus, and social welfare. Contrary to prior game theory research that generally shows that price discrimination based on purchase histories eventually results in lower profits for all firms, we find that firms’ profits from conducting price discrimination can increase with consumers’ loss aversion behaviour. We consider two scenarios where firms recognise and do not recognise consumers’ loss aversion and brand loyalty behaviour. We find that the profit with behaviour recognition is higher than that without behaviour recognition under the condition that consumers’ loss aversion concerns are sufficiently strong. However, both loss aversion and brand loyalty decrease consumer surplus. Besides, consumers’ loss aversion and brand loyalty behaviour can increase social welfare because they can reduce inefficient switching.

Full Quantity or Full Credit? Choosing the Right Buyback Policy for A Loss-Averse Retailer

This paper compares two forms of buyback policies commonly adopted in practice -- a traditional full-quantity partial-credit (FQ) buyback contract and an alternative full-credit partial-quantity (FC) contract. Standard theory based on profit maximization suggests that both policies can achieve channel-coordinating solutions when applied in a dyadic supplier-retailer setting. Consequently, neither policy should dominate the other by simultaneously offering higher expected profits for both parties. However, prior behavioral research in buyback contracts suggests that retailer's ordering decisions are often subject to behavioral biases. First, through a controlled lab experiment, we discover that the ordering decisions made by human retailers are significantly higher under the FC contract than under the FQ contract, although standard theory predicts no difference. This phenomenon is consistent with the behavioral tendency of loss aversion. Next, we study how the performances of the two contracts compare as a result of the retailer's loss-averse behavior. On the one hand, from a contract designer's perspective, it becomes feasible to design a channel-coordinating FC buyback contract that makes both players better off compared with a coordinating FQ contract. On the other hand, when the supplier has the authority to set contract terms, she should choose the FC policy to maximize her expected profit. However, in a situation where the wholesale price is exogenously given, the supplier should instead choose a traditional FQ contract for a loss-averse retailer. Our results can help inform both the contract designers and the supply managers on what types of buyback policies to use in different settings.