Loss Aversion

I can't come out to find you
I don't like to go outside
They can't turn off my feelings
Like they're turning off the light
--Phil Collins

Re our recent discussion of prospect theory, here is a picture of loss aversion expressed as a 'value function:' We can note several things.

Note that value is defined not in absolute terms, but in terms of change from a reference point A (a.k.a. the 'anchor').

Note the 'S-curve' nature of the value function. At small positive outcomes relative to the reference point, individuals enjoy relatively large gains in perceived value. As positive outcomes get larger, perceived value diminishes. The same thing happens in reverse for negative outcomes. Small negative outcomes relative to the reference point are associated with relatively large losses in value, while large negative outcomes generate incrementally less perception of loss.

Note, however, that the S-curve is not symmetical for gains and losses. The bottom of the S-curve associated with losses is deeper, meaning that negative outcomes are viewed more unfavorably than positive outcomes are viewed favorably. In the diagram, a positive outcome of x is associated with a gain of B, and a negative outcome of -x is associated with a loss of C. The absolute value of C is greater than B.

Axiomatically, when confronting decisions under condtions of risk, "losses loom larger than gains."