I. What is Loss Aversion?
A new paper out in the journal Psychological Research suggests that Kahneman & Tversky may have overestimated the effects of loss aversion.
(Loss aversion is the idea that people consider losses more emotionally noteworthy than gains, even when the amount being lost or gained is identical. For example, if you lose $10, you’ll be really angry. But if you find $10 on the ground, you’ll only be moderately happy).
Loss aversion has been a popular idea ever since Daniel Kahneman and Amos Tversky discovered it decades ago, even boasting its own (long) wikipedia page. But it’s also been quietly under fire for a while, and this paper’s author, Eldad Yechiam, is clearly skeptical. Yechiam’s literature review finds that loss aversion might exist for large amounts ($500+), but probably doesn’t apply to smaller amounts ($100 or less). Even when loss aversion is found, it doesn’t necessarily seem to reflect irrational or biased thinking.
II. How did the original studies get it wrong?
Yechiam identifies the following problems with loss aversion:
1. People react differently to winning and losing even when no loss aversion is found.
Even when people are put in situations where they don’t experience loss aversion, losing still has different physiological effects on the body than winning. For example, people’s heart rate increases and their pupils dilate more when they lose a certain amount than when they win that same amount, even in situations where most people don’t experience loss aversion. When asked to choose between different outcome probabilities, people sometimes take longer to respond to scenarios involving loss than scenarios involving an equivalent amount of gain. And risk and value appear to be calculated by different parts of the brain.
2. The early results that supposedly demonstrated loss aversion didn’t actually demonstrate loss aversion.
This one is a bit embarrassing. The Galenter & Pliner paper that Kahneman & Tversky cite to show the existence of loss aversion actually didn’t find it. Galenter & Plinter say that they expected to find a stronger preferences for avoiding loss than seeking gain, but didn’t.
Looking closely at a 1979 review by Fishburn & Kochenberger — which also supposedly identified loss aversion — reveals that Fishburn & Kochenberger transformed everyone’s data based on a complicated justification involving their wish to compare different individuals with different utility functions against each other. The transformations muddy the waters enough that the data is probably too suspect to be taken as a straightforward confirmation of loss aversion.
Also, a lot of the studies that Fishburn and Kochenberger review seem less that perfectly trustworthy. One study interviewed supposedly interviewed about a hundred executives and only presented the results for 7. Another interviewed 16 people and presented the results for 4 of them. Obviously, this kind of cherry-picking is not usually a great sign that your findings will replicate.
3. Some of the early studies were asking people about very large potential gains and losses
Everyone already knows that big losses are considered extra-bad, because “below certain cut-off points, negative outcomes can carry a future cost that is heavier than the direct immediate penalty, such as the change of future economic ruin.” In other words, “loss aversion” isn’t necessarily irrational. People might just be correctly perceiving that losing $1,000 really would be worse than gaining $1,000.
If I lose $1,000 and can’t make rent, I might become homeless, or my credit might go way down, or I might lose my rainy day fund and not be able to fix my car if it breaks down. Losing $1,000 can ruin your life, if it happens at a bad time. If I gain $1,000, by comparison, I would probably feel super great about it, but it’s unlikely that my life suddenly takes a massive upturn. It’s probably just an extra $1,000.
So in this case, I seem to be experiencing “loss aversion.” But if you look closer, I’m simply acting rationally. I understand that losing $1,000 might ruin my life, and also that gaining $1,000 is unlikely to supercharge my life, so I weight the two outcomes accordingly. I am risk-averse (I avoid big risks), but I am not loss-averse (I don’t avoid risks of all sizes).
Therefore, the finding that people don’t like to gamble when huge amounts of money are at stake doesn’t really need a new theory like loss aversion to explain it.
So how much money needs to be at stake for this risk aversion to kick in? The authors cite this very long 2013 review by Yechiam and Hochman, and conclude that anything under $100 probably won’t trigger significant risk aversion in the average study participant. They find that these results hold when real money is used.
4. Some of the early studies were asking people about decisions made at work that affected their company’s finances rather than their own finances.
(I should add a disclaimer that this isn’t mentioned in the 2018 Yechiam review, but I think it’s worth pointing out anyway].
It makes sense that people face different incentives at work than they do in their personal lives. One common argument against bureaucracy is that people are too incentivized to pick safe choices and not incentivized to take risky choices. If a risky choice pays off, your boss might give you an approving thumbs-up and think slightly higher of you; if a risky choice fails, you might be fired. Hence the business proverb “no one ever got fired for choosing IBM.”
If we’re trying to evaluate how people respond to risks and rewards, it probably doesn’t make sense to ask them about work (where they might be subject to complicated incentives or disincentives that we can’t see). It makes more sense to ask them about their personal lives.
III. What’s left for loss aversion
It’s not all bad for Kahneman and Tversky, or for loss aversion in general.
1. The reflection and framing effects that they identified seem to replicate pretty well (as demonstrated in this recent meta-analysis).
2. The results that loss aversion predicts — that people will avoid high-variance bets with low expected pay-offs because of the potential negative effects — are indeed found when the amounts of money at stake are large. This might not be due to biased and irrational thinking, as first proposed, but it’s still a valid result.
3. People do really seem to have larger reactions to (even small) losses than gains, as evidenced by physiological studies focusing on e.g. heart rate or pupil dilation. Now, this is true even in conditions where loss aversion is low, so it probably isn’t directly due to loss aversion as Kahneman & Tversky understood it. But it’s still evidence that they were partially correct, and that people seem to respond to losses more intensely than gains, at least in certain ways.
4. Losses appear to increase attention more than gains, even when the losses are fixed and don’t reflect participant performance. This implies that something about the act of loss has interesting impacts on human performance.
So Kahneman & Tversky correctly intuited that something interesting was going on when it came to the effects of losses as compared to gains. But the model that they produced to explain their findings seems to have been flawed. This isn’t surprising, and it’s nice to see diligent researchers carrying on in their wake.
TAKEAWAY FOR UX RESEARCHERS
- Loss aversion might exist for large amounts ($500+), but probably doesn’t apply to smaller amounts ($100 or less).
- Even when loss aversion is found, it doesn’t necessarily seem to reflect irrational or biased thinking. People are justifiably more worried about huge losses (which can ruin your life) than huge gains (which can definitely be great, but probably not as great as ruining your life would be terrible).
- Replication and framing effects seem to be holding up (for now).
- Losses do seem to focus attention and increase arousal more than gains.
Note: all links in the above blog post were cited by Yechiam in his paper in Psychological Research, with the exception of the Wikipedia link on loss aversion.
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