Loss aversion: what is this psychological phenomenon?

A psychological effect that follows this maxim: better not to lose than to win.

Let's imagine that we are in a contest and we are offered two options: to give us a total of 1000€ or to risk winning 1200€ with an 80% chance of winning it (although with a 20% chance of not winning anything).

What would we do? It is possible that some would decide to risk the second option, while many others would opt for the safer option..

This difference is due to the presence of different ways of thinking and the presence of different cognitive and emotional biases and tendencies. In the case of those who choose not to take the risk and obtain the smaller but safe amount, their action can be explained to a large extent by the concept known as loss aversion, which we will discuss throughout this article.

Loss aversion: what are we talking about?

Loss aversion is the name given to the strong tendency to prioritize not losing over winning.. This tendency is understandable as a resistance to loss due to the high emotional impact that the possibility of losing generates, a possibility in fact the presence of losses generates an emotional activation much greater than that caused by a possible gain (specifically about two or two and a half times more).

We are facing a type of heuristic or mental shortcut that can provoke a cognitive bias that favors non-risky behaviors for fear of losses: we may not take risks to obtain a good of greater utility or even take risks and lose more than necessary if we are trying to avoid a loss. We place a higher value on what we have than what we stand to gain, something that means that we tend to try to avoid losing more than anything else unless what there is to gain is very attractive..

Keep in mind that loss aversion is not good or bad in and of itself, and it makes evolutionary sense: if we have a food source a few meters away but we can see a predator several meters away, it is possible that taking the risk will result in death. Or in the example of the introduction: we are going to take 1000€, do those extra 200€ compensate for the possibility (however small) of not earning 1000€?

In short, aversion to loss seems to be a psychological predisposition that corresponds to survival mechanisms that have evolved throughout our lineage, and this is expressed in terms of both physical and economic losses..

Fundamental point of prospect theory

This concept is one of the key elements of the prospect theory of Kahneman and Tverskywho investigated human decision making and developed the expected utility hypothesis (which states that when faced with a problem or situation in which we have to make a decision, we tend to choose the option that we consider most useful in terms of cost/benefit). Thus, loss aversion is contextualized in the framework of decision making, and is based on the belief that the risky behavioral option may lead us to experience greater costs than benefits.

However, even if this loss aversion exists, it does not mean that our behavior will always be the same. Our choices depend to a large extent on the frame of reference from which we start out.If we are faced with a choice that can safely bring us a profit, we tend to opt for the most probable option, even if it is smaller, while in the case of a choice that can only bring us a loss, our behavior is usually the opposite (we prefer to have an 80% chance of losing €120 rather than having a guaranteed loss of €100).

This last aspect leads us to point out that loss aversion is not risk aversion per se: we can risk losing more rather than losing a smaller fixed amount.

It is important to bear in mind that this loss aversion is not always equally strong: it is not the same to guarantee 100 euros or to be able to reach 120 as it is to guarantee 100 but opt to win 100,000. How relevant it is to us, or in other words the incentive value of the stimulus in question that we can achieve, is also a factor that can influence our choices.

In what areas does it affect us?

The concept of loss aversion has generally been associated with the economic sphere.for example, valuing behavior in business environments, gambling or the stock market. However, we are talking about behavioral economics, not just monetary economics.

And we must bear in mind that loss aversion is a cognitive bias that is present in other facets of life: it is part of our decision making in terms of employment, studies (an easy example of this is when we face a test with a penalty for error) or even when establishing action plans.

Loss aversion has also been observed in behavior in the face of aversive emotional stimuli, and this tendency has even been analyzed in subjects with psychopathologies such as major depression, in which loss aversion seems to occur to a greater extent and to generate a lower tendency to risky behavior than in non-clinical subjects.

Neuroanatomical implication

Loss aversion has generally been studied at the behavioral level, but some studies (such as the one by Molins and Serrano in 2019) have also investigated which brain mechanisms may be behind this tendency.

The different studies analyzed seem to indicate that there would be two systems, an appetitive and an aversive onethat interact and allow us to make a decision. Within the first one, which would have activity when possible gains are registered and not in the face of losses and which is associated with the search for rewards, the striatum and a large part of the [frontal cortex](/neurosciences/prefrontal-cortex] stand out. In the second, the aversive, the amygdala (which is logical if we consider that it is one of the structures most closely linked to fear and anger) and the anterior insula stand out, in addition to other brain regions.

Thus, the brain processes information differently depending on whether it has to do with chances of winning, or whether it is more related to losses. This means that both processes can be different in terms of their emotional implications, producing the asymmetry that is behind loss aversion.

Although these systems are complex and it is not yet clear how they work, when the subject is faced with a choice in which he/she may lose, the appetitive system is deactivated (unless what can be gained is considered a sufficient incentive to take the risk) and the aversive system is activated. (unless it is considered that what can be gained is a sufficient incentive to take the risk) and at the same time the aversive system would be activated. This would lead to a cognitive and behavioral reluctance to lose. Likewise, it is suggested that there may be patterns of brain functioning that, even without facing a decision, are linked to a cognitive style that tends to this aversion to loss.

Bibliographical references:

• Gal, D.; Rucker, D.D. (2018). Loss Aversion, Intellectual Inertia, and a Call for a More Contrarian Science: A Reply to Simonson & Kivetz and Higgins & Liberman. Journal of Consumer Psychology, 28(3): pp. 533 - 539.
• Kahneman, D., Knetsch, J. and Thaler R. (1991). The endowment effect, loss aversion, and status quo bias: anomalies. J Econ Perspect, 5: pp. 193 - 206.
• Kahneman, D. and Tversky, A. (1979). Prospect theory: an analysis of decision under risk. Econometrica, 47: 263-91.
• Molins, F. y Serrano, M.A. (2019). Bases neurales de la aversión a las pérdidas en contextos económicos: revisión sistemática según las directrices. Prisma Revista de Neurología, 68: pp. 47 - 58.
• Seymour, B.; Daw, N.; Dayan, P.; Singer, T.; Dolan, R. (2007). Differential Encoding of Losses and Gains in the Human Striatum. Journal of Neuroscience 27(18): pp. 4826 - 4831.
• Yechiam, E.; Hochman, G. (2013). Loss-aversion or loss-attention: The impact of losses on cognitive performance. Cognitive Psychology, 66(2): pp. 212 - 231.