Loss aversion

Daniel Kahneman

Daniel Kahneman

I was struck by the vagaries of the lottery while watching a report on ABC News.  A wiley reporter asked several people if they would sell their Powerball ticket for $4 doubling the $2 they paid for it.  Each person refused the offer and seemed quite incredulous that the reporter would even ask.  I could not help thinking that it sounded like what Daniel Kahneman and Amos Tversky called loss aversion1.   More about that in a moment.

The behavior does seem capricious.  The odds were 1 out of 292 million to win $415 million2, but each person refused to sell claiming they might lose the millions.  Apparently it never occurred to them to sell the ticket and buy two more effectively doubling their chances of winning.  Nor did it make sense to them to sell the ticket and buy two additional tickets one with the same number they sold.  That may require having to split the winnings, but would that be onerous if they won especially considering the almost unimaginable odds against winning?

The magnitude of the chance to win is difficult to put into perspective, but it helps me to think in terms of toothpicks.   There are 250 toothpicks in a typical toothpick box and 73,000 give the requisite 292 million toothpicks needed to simulate the lottery odds.   Imagine only one toothpick in the 73,000 boxes is colored red.  If you could stack each box on top of one another, they would reach about 6,083 feet into the air – more than 800 feet higher than a mile.  Picture all those boxes being emptied, you being blindfolded and asked to scramble through the pile, and coming out with just one.  The odds of you picking the red toothpick are equivalent to you buying the winning lottery ticket.

But let’s get back to the original theme – loss aversion.   Daniel Kahneman is a psychologist, and normally psychologists are not in line to win Nobel Prizes in economics.  But he did in 2002 for his development of Prospect Theory, encompassing loss aversion, which attempts to explain the psychological impact of gains and loses.  He summarized his work in his best selling book Thinking, Fast and Slow3.   Prospect theory recognizes that humans are not completely rational.  They are risk averse and weigh losses much more heavily than gains (that is, loss aversion).

Let’s take for example a wager on the toss of a coin.  Tails you lose $100, heads you win $150.  Common sense tells us that winning more than we lose is a good bet.  After all, Vegas casinos make their livings on much less odds in their favor.  But most people will not take the bet.  They have a loss aversion.  Most require to win at least $200 before they accept the odds.

No need to get into much more detail on loss aversion, but I highly recommend Kahneman’s book if you crave more detail.   We can probably explain the unwillingness of some to sell their lottery tickets for double its’ worth because of loss aversion.  There must be a heuristic that imparts a need to keep that potential winning ticket even in the face of mind-boggling odds.  Perhaps loss aversion is hard-wired into our brains (that is, genetic).  Many of the genetic characteristics that make us human evolved within small hunter-gatherer tribes thousands of years ago4.

If our hunter ancestors were cutting up the carcass of an animal too large to carry, and a lion saw them and charged, it does not take too much imagination to believe they would take what they could and run rather then fight for the remainder.  They certainly would not be brain storming over what the rational decision would be.  You don’t get your genes passed on by taking time to formulate a rational path of action under do or die circumstances.

  1. Kahnerman, D. and Tversky, A. (1992) Advances in prospect theory: Cumulative representation of uncertainty: J. Risk and Uncertainty , 5, 297-323.
  2. The lump sum payout at $415 million is about $202 million after taxes which means paying for a $2 ticket is statistically a bad bet not that any of us would turn the money down.  And this does not consider the possibility of sharing the winnings with other winners.
  3. Kahneman, D. (2011) Thinking, Fast and Slow: Farrar, Straus and Giroux.
  4. Pinker, S. (2002) The Blank Slate: New York: Penguin.
13 replies
  1. dlongdue
    dlongdue says:

    loss aversion defines as refers to people’s tendency to prefer avoiding losses to acquiring equivalent gains. In this article by Marc Defant explains loss aversion by giving certain examples and scenarios. The first scenario he gave was how people were not willing to sell their $2.00 lottery tickets for $4.00 essentially doubling what they spent when asked by a reporter. The loss aversion here refers to the fear people had when it comes to missing losing a potential at $415 Million despite the enormous odds against them actually winning. The example he gave to illustrate this was how if you were to blindfold a person and asked them to pick out red toothpick out of a section of many. Dr. Kahneman also explained prospect theory to explain loss aversion. According to the doctor people will not risk losing a small amount in order to gain a larger amount. The Example the author gave to show this was flipping a coin and winning a bigger amount then you would lose. People are unwilling to risk losing at all even if it means winning more. The author seems to think that loss aversion is hard wired in our brains and is therefore genetic. However, I think that it all depends on the situation. If the risk is low and the gain is high I feel people are more willing to take the risks. In conclusion, we all have loss aversion in some way. We all hope to win the lottery someday but some are just willing to risk more to do it.

  2. astahl
    astahl says:

    Ashley Stahl – Comment Requirement (Intro to Earth Science)

    This article is interesting to me for the fact that it definitely seems like something you learn to do. Weighing the pros/cons of a certain situation, in this case selling a potential winning lottery ticket. I am surprised that people would be against selling the ticket for double of what it was worth, and then just going to buy the same ticket plus another. But on the other hand, I can also see someone not wanting to share that potential winning money. A study would be interesting in how different people handle loss aversion, because it would get an inside look of how peoples brains operate with gains/losses.

  3. JordanPhilyor
    JordanPhilyor says:

    This article examines the theory of “Loss Aversion”. “Loss Aversion”, created by Amos Tversky and Daniel Kahneman, is theory that aims to explain how gains and losses influence how we make decisions. The main example of Loss Aversion in this article was the willingness (or unwillingness) of people to sell their lottery tickets for double what they bought them for. Many people failed to understand that what they could gain from selling their lottery tickets is much greater that what they lose by not selling it, due to the small odds of winning the lottery. The toothpick example was instrumental in explaining this theory relative to the lottery. In this example, toothpicks were used to simulate the odds of winning the lottery.

  4. Albert Campbell
    Albert Campbell says:

    Loss aversion is a principle explaining how people avoid losses to more of an extent than their desire to gain. It is driven by a psychological imbalance of losses and gains where losses are felt more than the affect of a gains. This explains the tendency of people to make irrational decisions if it will reduce the chances of any kind of a loss. It is demonstrated by the difficulty people have when selling a lottery ticket which is nearly guaranteed to not give them benefit. A person’s fear of losing out on the marvelous prize associated with the lottery completely outweighs a guaranteed option to gain money at a much smaller magnitude. However, the concept of loss aversion can go further than economic examples.
    Because this is such a widespread phenomenon, it makes sense that it would be coded within human, and likely most animals, DNA. Our ancestors had to be cautious yet willing to take risks, so for the most evolutionarily favorable imbalance would likely arise. Going hungry for a night obviously would be valued less than losing your ability to reproduce and pass on genetic information, and how different circumstances are valued all influence how ancestors made decisions. We have come to make loss-based decisions today, like a person’s reluctance to sell a house at a loss even if they live in a potentially dangerous area. The desire not to lose out can explain many ways humans made decisions throughout their evolutionary history, as well as how we make decisions today.

  5. LaudEssandoh
    LaudEssandoh says:

    After reading your essay, I went ahead and purchased the book you had mentioned. It seems like Loss Aversion is a very tricky thing and can masks itself as common sense, when in reality it can be a misguiding sense of intuition. The paragraph where you had mentioned the lottery tickets had me examining the situation in its entirety. I imagined what I would do in that position, and I realized I would rather risk losing potential millions as opposed to winning it all and risk losing all my friends and loved ones. When assessing the cost/benefit analysis and loss aversion, one must think a situation through in it’s entirety to really weigh out the odds.

  6. Catherine Engeleit
    Catherine Engeleit says:

    The article “Loss Aversion” is about the economics principle that was created by Daniel Kahneman and Amos Tversky. This principle discusses our willingness to give up things in our lives, much like gains and losses from something that is done in life. One example that is used in the article is a prime example to help understand this concept. When talking about whether or not someone was willing to give up their lottery ticket for a net profit of two dollars, people were not willing to do so. This is because there is more money at stake than just two dollars even if the odds are stacked against them. They will still take the risk and keep their ticket for the off chance that they have the winning numbers. Also, the article goes into other examples that help explain loss aversion that are truly good ones. The concept of loss aversion is definitely and interesting one. The fact that Kahneman uses that psychology aspect of this concept is very interesting.

    I personally found this article very interesting. Since I am an economics major, I was thoroughly enlightened about this concept of Loss aversion and look forward to learning about it as I continue my studies in economics. I will definitely remember this article when I have to start studying this topic to help me remember exactly what loss aversion is. The article definitely left me with something to think about the next time I play the lottery or just have to weigh the pros and cons of giving up something.

  7. HarleeA
    HarleeA says:

    This article is very interesting and I’m absolutely going to look into purchasing Kahneman’s book because I am definitely “craving more detail”! I feel like this is a great way that humans play psychological games against themselves. With the odds of winning the lottery being 1 in 292 million, most people can’t dispute that they are most likely NOT going to win. But even though they know this to be true, they still hold onto the glimmer of hope that they will, in fact, win these almost impossible odds. So instead of selling their $2 ticket for $4 to actually make an extra $2 or using the money to buy 2 tickets and even buy one with the same numbers, they keep their ticket. Unless they are the lucky winner, they gain nothing and even lose out! Its almost like they are cheating themselves out of something better because they aren’t looking at all the different routes they could’ve taken, just the one that makes the most sense in the moment and “keeps them from losing”. Although I’m sure we all try to be positive about life, I feel as though its only natural to look at what we lose instead of what we could gain, and I think this is a great example of that. I’m not sure that genetics play a role in this. Although I do think its only natural to pick the route that you think would keep you from losing the most, I’m sure there are just as many people who would’ve thought about the flip side of the situation and realized that the other way could be just as benefitting.

    Also, I wonder if they would have done a study afterwards to see how many people regretted not selling their ticket for whatever reason, how high that percentage of people would be. I think it would be interesting to see how many people regretted not selling their ticket because they realized after that they could’ve gained $2, how many people regretted not selling it because they didn’t think about buying 2 more, or how many people didn’t regret it at all. Maybe this feeling of regret or not could’ve added to the report and might go even deeper into the concept of loss aversion.

  8. Marie Jean
    Marie Jean says:

    This is quite interesting! I don’t like buying lottery tickets because the odds of me winning are so little. If I did finally buy one and somebody came and offered me 4 dollars for the ticket, I would be rather suspicious. “Do I have the winning ticket and he knows it?” I would have refused to sell solely based on that reflection. Never connecting the dots, that I could buy another ticket with the exact same numbers plus getting an additional one to double my chances of winning.

    It would make sense that we are genetically wired to take the safe route based on your example. But then again, selfishness is just as big a reason to not want to sell the ticket at 4 dollars even with the possibility of doubling our chances (and even getting the exact same numbers for one of the tickets). Because if that first ticket was really the winning ticket, and you bought a duplicate of it, the prize would have to be split between the two of you, not to mention anybody else lucky enough to have pulled out the winning numbers.

  9. courtney piccirilo
    courtney piccirilo says:

    I would have to agree with the comment above from kyle, it would be interesting to conduct a study with those who come from money and those who do not to see if it is more genetic or learned impulses. It is hard to decide which one for me, although I am leaning more towards learned behavior seeing as everything else growing up we learn visually from the start with watching our parents and how they do things or react to something. Even though I agree with it would make sense to take the $4 and buy two more lottery tickets, I believe people will not because they get scared to lose lots of money as if they have the winning ticket

  10. Kyle Griffin
    Kyle Griffin says:

    This seems very interesting to me. I do wonder as well if it is a learned behavior or possibly a genetic one. Testing would be rather difficult as if everyone in a population denied to sell their ticket it may be some part of their culture or possibly all genetic. I find it funny how you could essentially split the winning and still give yourself another chance yet people could only see their singular ticket instead of the larger solution. I recently watched a video on Youtube will Bill Nye going over the lottery and while he declared it a tax on the stupid do to how small a chance of winning was people still go for the long shot because “someone has to win and if I play it could be me”. Another interesting fact about the lottery is that more low-income people play it. This fact surprised me as I figured they would not throw away their money as easily as it is a larger percent of their income. The study claims they feel it is more equal so it does not matter if you’re rich or poor as everyone has the same odds. Members of the study could also be primed by saying their relation to being wealthy or not and those in lower categories would buy a ticket more often compared to if they were told they were wealthy.

    Haisley, E., Mostafa, R. and Loewenstein, G. (2008), Subjective relative income and lottery ticket purchases. J. Behav. Decis. Making, 21: 283–295. doi:10.1002/bdm.588

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