There is a very interesting debate going on for some time already about a psychological effect called “loss aversion” [1]. This effect, and many other similar psychological effects describing the peculiarities of human decision making, underpins the field of behavioral economics and behavioral finance.

This effect has been called a fallacy.

The popular idea that avoiding losses is a bigger motivator than achieving gains is not supported by the evidence.

To get up to speed: this piece by Barry Ritholtz in Bloomberg [9] reported on a paper by David Gal and Derek Rucker entitled “The Loss of Loss Aversion: Will It Loom Larger Than Its Gain?” [2]. The paper was summarized by the first author in Scientific American [3]. You can also read comments on the original paper by Itamar Simonson and Ran Kivetz [4] and by Tory Higgins and Nira Liberman [5] and Gal and Ruker’s reply [6].

The main idea behind loss aversion is rather simple: losses have more profound psychological effect on us compared to gains of the same magnitude. Such effect has been described by Kahneman and Tversky in their seminal paper on a descriptive theory called Prospect Theory [1]. However, in [2] the authors assert that “current evidence does not support that losses, on balance, tend to be any more impactful than gains” and broadly criticize scientists for sticking to wrong concepts despite the evidence pointing to the contrary.

How important that is? Well, it is quite important:

Loss aversion is cited widely across the social sciences in law, medical decision making, political science, marketing, finance, consumer psychology and many other areas, and has even entered the popular lexicon. It has been cited as an explanation for many well-known phenomena, such as the compromise effect, the disposition effect, the default effect, and the equity premium puzzle. It has been celebrated (“Three Cheers – Psychological, Theoretical, Empirical—for Loss Aversion;”), recognized as a “seemingly ubiquitous phenomenon”, and described as “one of the most fundamental and well-documented biases in information processing…” .

[2]

The concept of loss aversion is certainly the most significant contribution of psychology to behavioral economics.

Kahneman in [8]

Where would the problem be?

(…) it is often the case that efforts are not undertaken to qualify loss aversion or explicitly state, for instance, that circumstances and psychological processes exist that lead losses and gains to have similar psychological impact, or that lead gains to loom larger than losses. Indeed, even when researchers who accept loss aversion discuss “boundaries of loss aversion,” they tend to reinforce and anchor on the basic idea that losses have fundamentally greater impact than gains.

(…)

Put simply, most writings on loss aversion appear to accept the assumption that losses do loom larger than gains and deviations from this are aberrations and violations of the norm that do not challenge the basic principle.

[2]

This is an example of status quo bias [7]. We focus on explaining our results as exceptions to the norm rather than as evidence that our assumptions are wrong. (Funnily enough, loss aversion is one of the explanations of the status quo bias.)

When the experiments are extended slightly beyond simple loss and gain questions, the loss aversion seems to disappear even for low stake questions. Consider this experiment:

(…) a review of over 30 papers finds little evidence that losses loom larger than gains in the context of risky choice when a bet with even odds of gaining and losing is not framed as the action option. We recently found additional support for this conclusion in two separate runs of an experiment conducted with participants from MTurk. In particular, we asked participants to imagine they faced a choice between either (A) receiving $0 with 100% chance or (B) receiving $15 with 50% chance or losing $15 with 50% chance. In both runs, participants exhibited a trend towards the choice of the risky option. Thus, we did not find evidence for participants to avoid loss any more than they pursued gain in risky choice.

[2]

Also, when comparing low stakes and high stakes options the loss aversion seems to disappear:

(…) in a choice between (A) a bet that offered a 50% chance of winning 1 point and a 50% change of losing 1 point, and (B), a bet that offered a 50% chance of winning 4 points and a 50% chance of losing 4 points, just 49% of participants chose the lower stakes bet. This is inconsistent with the idea of loss aversion that predicts that individuals should be more motivated to avoid the larger potential loss. Likewise, contrary to the predictions of loss aversion, research shows that individuals are no less risk averse when choosing between different potential gains (…) than when choosing among options where one of the choices involves potential for loss.

[2]

The debate is very interesting and worth following. Critics of Gal and Rucker write that their extraordinary claim requires extraordinary evidence and that “the authors failed to make a case that convincingly rebuts the accumulated research”. This is an odd requirement given that Gal and Rucker claims that the “accumulated research” is wrongly interpreted in the first place and subject to the status quo bias. How much evidence is needed to disprove something? In natural sciences, as elaborated by Popper [10] and Kuhn [11], even one experiment can break the status quo and result in a paradigm shift. In social sciences the situation looks a bit different, but calling any body of knowledge extraordinary just because it exists is flawed too and continuous critical reevaluation of old concepts is needed if any progress is to be achieved.

[1] Daniel Kahneman, Amos Tversky. Prospect Theory: An Analysis of Decision under Risk, Econometrica, 47, 2, 263 (1979).
[2] David Gal, Derek Rucker. The Loss of Loss Aversion: Will It Loom Larger Than Its Gain? Journal of Consumer Psychology, 28, 3, 497 (2018).
[3] David Gal. Why the Most Important Idea in Behavioral Decision-Making Is a Fallacy, Scientific American, July 31, (2018).
[4] Itamar Simonson, Ran Kivetz. Bringing (Contingent) Loss Aversion Down to Earth — A Comment on Gal & Rucker’s Rejection of “Losses Loom Larger Than Gains”, Journal of Consumer Psychology, 28, 3, 517 (2018)
[5] E. Tory Higgins and Nira Liberman. The Loss of Loss Aversion: Paying Attention to Reference Points. Journal of Consumer Psychology, 28, 3, 523 (2018).
[6] David Gal, Derek Rucker. Loss Aversion, Intellectual Inertia, and a Call for a More Contrarian Science: A Reply to Simonson & Kivetz and Higgins & Liberman. Journal of Consumer Psychology, 28, 3, 533 (2018).
[7] William Samuelson, Richard Zeckhauser. Status Quo Bias in Decision Making, Joumal of Risk and Uncertainty, 1, 7-59 (1988).
[8] Daniel Kahneman, Thinking, Fast and Slow, 2011.
[9] Barry Ritholtz, A Challenge to the Biggest Idea in Behavioral Finance. Bloomber, August 9 (2018).
[10] Karl Popper, The Logic of Scientific Discovery  Routledge, 1959.
[11] Thomas Kuhn, The Structure of Scientific Revolutions. University of Chicago Press, 1970.