Is loss aversion magnitude dependent?

Researchers: Sumitava Mukherjee, Narayanan Srinivasan, V.S.C Pammi & Narayanan Srinivasan

Many of us have bought or seen somebody buying tomatoes. The first interesting question in the customer is the current price, with reference to the known or remembered price from the past purchase. Prospect Theory’s value function explained this relative valuation through the principle of loss aversion which says, people weight losses more than gains emotionally. So, a gain of 10 is psychologically less than a loss of 10.

Interestingly, a large number of studies have looked at big magnitudes. But, we were concerned about the average customer taking a walk in the evening looking to purchase tomatoes : We were thinking about small amounts.

Loss aversion is one of the hall-mark concepts in social sciences which would predict that a gain or 10 should have less effect on our emotions than a loss of 10. However, we often saw people who would be pretty happy to know that the tomatoes are a bit cheaper – maybe by 10 or 5 units compared to the last purchase 2 days back. That was intriguing and hence we did a series of experiments asking people what they thought would have more effect on their feelings across two contexts : gambling and price changes.

We conducted an experimental study to check what happens. And wow! Across four different experiments conducted online in India, we found that losses did not loom larger than gains : we did not find loss aversion! And, wow! we were not alone. A handful of studies conducted at multiple labs in different countries did not find what Prospect theory’s value function suggests: loss aversion did not show up at small magnitudes. This would mean that loss aversion is magnitude dependent. When we increased the amounts, we started to see loss aversion (losses being weighed more than gains) in the same individual.

Prospect theory is beautiful – an elegant explanation about how we think about magnitudes and uncertainty. It also was a major contribution that was cited in the Nobel prize ceremony when Daniel Kahneman got the nobel prize for his phenomenal contribution to behavioral economics. But, the value function does not hold for stakes of all magnitudes. I have started to wonder how our preferences could be colored by magnitudes and how, we cannot always say losses loom larger than gains.

Prospect Theory proposed that the (dis)utility of losses is always more than gains due to a phenomena called ‘loss-aversion’, a result obtained in multiple later studies over the years. However, some researchers found reversed or no loss-aversion for affective judgments of small monetary amounts but, those findings have been argued to stem from the way gains versus losses were measured. Thus, it was not clear whether loss-aversion does not show with affective judgments for smaller magnitudes, or it is a measurement error. This paper addresses the debate concerning loss-aversion (in the prospect theoretic sense) and judgments about the intensity of gains and losses. We measured affective prospective judgments for monetary amounts using measurement scales that have been argued to be suitable for measuring loss-aversion and hence rule out any explanations regarding measurement. Both in a gambling scenario and in the context of fluctuating prices, potential losses never loomed larger than gains for low magnitudes, indicating that it is not simply a measurement error. Moreover, for the same participant, loss aversion was observable at high magnitudes. Further, we show that loss-aversion disappears even for higher monetary values, if contextually an even larger anchor is provided. The results imply that Prospect Theory’s value function is contextually dependent on magnitudes.

Mukherjee, S., Sahay, A., Pammi, V. S. C., & Srinivasan, N. (2017). Is loss-aversion magnitude-dependent? Measuring prospective affective judgments regarding gains and losses. Judgment and Decision Making, 12(1), 81-89.

A personal note: One of the co-authors (Professor Pammi) passed away. This is a remembrance about his smiling, eager, intelligent and jubilant times.

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