Reverse Loss Aversion in Small Gains

Like most people, I am painfully and personally aware of the behavioral finance finding that investors exhibit loss aversion, generally getting more pain from losses than pleasure from gains. Interestingly, however, loss aversion apparently reverses itself when smaller amounts of money are involved. Here is an abstract from a new study:

In a series of three experiments, we found that for small outcomes, [loss aversion] is reversed, and gains loom larger than losses. We explain this reversal on the basis of (a) the hedonic principle, which states that individuals are motivated to maximize pleasure and to minimize pain, and (b) the assumption that small losses are more easily discounted cognitively than large losses are.

Makes some sense. We are all reasonably good at shrugging off small losses, but we get really nutty when large numbers are involved. Other than starting a dry cleaner and exploiting people’s willingness to leave money in their clothes, there must be a way of taking advantage of this.

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  5. Wal-mart’s Inglewood Loss

Comments

  1. dub dub says:

    A casino.

  2. Thought of it, but scared off by regulation and capital requirements.

  3. dub dub says:

    A click-fraud network then! It’s not illegal, though crowded and morally dubious…

  4. Brent Buckner says:

    Penny stock promotion?

  5. John H says:

    You can sell it as entertaiment like the TV show “Deal or No Deal”. I read that economists are studying this show for risk aversion behavior.

  6. Morten says:

    There are … they are called the Lottery (small losses) and insurance (big losses).

  7. Morten — Same problem as casinos, unfortunately: Regulation and irritating capital requirements.

  8. How about Premium SMS Contests… Pricing discussed per message (under $2), but each number receives several a week, costing over $30 a month. (e.g. http://www.wixawin.com/ca/products.html)
    Or “cancel anytime, first one free” video subscriptions. (e.g. http://www.girlsgonewild.com)

  9. MQ says:

    Noting threshholds on the low end…I would be curious to see research that discusses when behavorial changes occur on the upper end (large asset base). Or maybe its a question of gross or relative loss.

  10. Ajay Mishra says:

    Online dating versus Social Networking