Loss Aversion Bias

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Description of Loss Aversion Bias. Explanation.

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Definition Loss Aversion Bias. Description.


Loss Aversion Bias is the human tendency to prefer avoiding losses above acquiring gains. Loss aversion was first convincingly demonstrated by Amos Tversky and Daniel Kahneman.


This form of Cognitive Bias may lead managers to risk aversion when they evaluate a possible business proposition; people prefer avoiding losses to making gains.  It is a human tendency that is particularly relevant for risk managers, professional valuators and decision makers in general.


Loss Aversion in Decision Making for Oneself and for Others

 

In studying the influences of loss aversion on decision making, Polman (2012) makes a distinction between decision making for oneself and decision making for others’ consumption, such as in interpersonal and intergroup situations.
Polman hypothesizes that people that make decisions for others are less loss averse than those who make decisions for themselves. What are the reasons decision making for others’ is different compared to decision making for oneself?

  1. Psychological distances. First of all, there seem to be differences in thinking systems between people who make decisions for oneself and for others because of psychological distances. The higher psychological distances are, the more abstract and de-contextualized people think. Increases in psychological distance results in decreasing loss aversion.
  2. Regulatory focus. In this case a distinction is made between prevention and promotion focus. The former are more concerned with negative outcomes while the latter is concerned with the presence or absence of positive results. Those who focus on negative outcomes are thus more sensitive to losses than those who are promotion-focused. People who make decisions for others tend to be more focused on promotion, while people who decide for themselves tend to think more about the possibilities of negative outcomes; as a result people who make decisions for others are less loss averse when considering regulatory focus.
  3. Searching for Information. When making decisions for others, people tend to search for more information relative to making the decision for oneself. One of the benefits of acquiring lots of information is that it shows less loss aversion. Think of stockholders who have a diversified number of stocks. They will be less loss averse in comparison with those who have only a limited number of stocks. Thus also regarding information seeking, deciding for others leads to relatively less loss aversion.
  4. Omission Bias. Omission bias is the tendency to consider harmful actions as worse than equally harmful omissions, because actions are more obvious than omissions. Making decisions oneself is more biased to omissions, mainly because people want to avoid the feeling of being responsible for potential losses.
  5. Power. People with more power experience less loss aversion. Furthermore, people that make decisions for others tend to think they have power over others. They feel they can control others by making decisions for them. Therefore, decision makers for others seem to be relatively less loss averse.

Source: Polman, E. (2012) “Self-other decision making and loss aversion” Organizational Behavior and Human Decision processes Vol. 119 Iss. 2 pp 141-150


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