Decision theory | Prospect theory
Loss aversion
Loss aversion is the tendency to prefer avoiding losses to acquiring equivalent gains. The principle is prominent in the domain of economics. What distinguishes loss aversion from risk aversion is that the utility of a monetary payoff depends on what was previously experienced or was expected to happen. Some studies have suggested that losses are twice as powerful, psychologically, as gains. Loss aversion was first identified by Amos Tversky and Daniel Kahneman. Loss aversion implies that one who loses $100 will lose more satisfaction than the same person will gain satisfaction from a $100 windfall. In marketing, the use of trial periods and rebates tries to take advantage of the buyer's tendency to value the good more after the buyer incorporates it in the status quo. In past behavioral economics studies, users participate up until the threat of loss equals any incurred gains. Recent methods established by Botond KÅ‘szegi and Matthew Rabin in experimental economics illustrates the role of expectation, wherein an individual's belief about an outcome can create an instance of loss aversion, whether or not a tangible change of state has occurred. Whether a transaction is framed as a loss or as a gain is important to this calculation. The same change in price framed differently, for example as a $5 discount or as a $5 surcharge avoided, has a significant effect on consumer behavior. Although traditional economists consider this "endowment effect", and all other effects of loss aversion, to be completely irrational, it is important to the fields of marketing and behavioral finance. Users in behavioral and experimental economics studies decided to cease participation in iterative money-making games when the threat of loss was close to the expenditure of effort, even when the user stood to further their gains. Loss aversion coupled with myopia has been shown to explain macroeconomic phenomena, such as the equity premium puzzle. (Wikipedia).
