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The Effect of Myopia and Loss Aversion on Risk Taking: An Experimental Test
Abstract
Myopic loss aversion is the combination of a greater sensitivity to losses than to gains and a tendency to evaluate outcomes
frequently. Two implications of myopic loss aversion are tested experimentally. 1. Investors who display myopic loss aversion
will be more willing to accept risks if they evaluate their investments less often. 2. If all payoffs are increased enough
to eliminate losses, investors will accept more risk. In a task in which investors learn from experience, both predictions
are supported. The investors who got the most frequent feedback (and thus the most information) took the least risk and earned
the least money.
... Punishment has received disproportionately less attention in the organization and management literature compared to incentive mechanisms (Tyler & Blader, 2005). On the contrary, a significant body of literature indicates that individuals place much greater emphasis on negative impact than positive one (Thaler et al., 1997;Tversky & Kahneman, 1973). A comprehensive multidisciplinary study (e.g., psychology, history, religion) by Rozin & Royzman (2001) reveals that negative phenomena receive more attention than positive phenomena, and negative entities are more salient and contagious than positive ones. ...
... A comprehensive multidisciplinary study (e.g., psychology, history, religion) by Rozin & Royzman (2001) reveals that negative phenomena receive more attention than positive phenomena, and negative entities are more salient and contagious than positive ones. Since individuals tend to emphasize avoiding negative outcomes more than striving for positive ones, punishments tend to have a lasting effect on organizational members (Thaler et al., 1997). As such, asymmetrical consideration of negative possibilities vis-à-vis positive possibilities, as well as reacting more strongly to losses than gains (Tversky & Kahneman, 1973), could drive individuals to do their best to avoid punishment and perform better. ...
... On the other hand, if individuals experience less punishment than their colleagues, they could again underperform because of the perception that they are not subject to punishment or are less likely to experience punishment (cf. Thaler et al., 1997). In essence, individuals could believe they could get away with undesirable behavior due to a lack of punishment. ...
Despite the prevalence of punishment as a method of enforcing organizational policies, management literature provides little guidance on the impact of punishment on individuals' work performance. A sample of 412 professional soccer players in England's Premier League was utilized to collect unobtrusive, longitudinal data to better understand how individuals react to punishments in their workplace. Our findings indicate that individuals deploy significantly more effort (run more kilometers) following a punishment. However, the findings also indicate that individuals do not perform better following the administration of punishment. In fact, their performance is significantly lower than before the punishment. Although individuals work harder, they actually perform weaker. Further, we found that, when punished more than their team members, individuals deploy significantly more effort than individuals who get punished less than their team members but perform significantly weaker than those individuals.
... On the one hand, considering the time value of funds, obtaining a subsidy in advance can improve an individual's subjective utility. On the other hand, since the individual receives the subsidy before water saving is completed, according to the prospect theory value curve (Fig. 3), individuals are averse to the loss of subsidies should they fail to meet their water-saving goals, which is called "Loss Aversion" (Sagemüller and Mußhoff, 2020;Thaler et al., 1997;Kahneman and Tversky, 1979). Due to the negative utility brought by losses is greater than the positive utility brought by gains of the same magnitude, and it is necessary to construct an improved explicit subsidy scenario that provides subsidies to farmers in advance to encourage them to participate in the WSI. ...
... The results show that individuals with higher discount rates have a preference not to engage in WSI construction. A high discount rate implies a preference for a present gain and a lower perception of future long-term benefit, called myopia (Thaler et al., 1997). Farmers are one of the groups with higher subjective discount rates (Damigos et al., 2021). ...
The world is confronted with increasing droughts exacerbated by the inefficiency of irrigation, and water-saving irrigation (WSI) holds the potential to alleviate this dilemma. Since individual farmers are important participants in WSI, it is imperative to account for their decision preferences. In addition, previous research did not consider the decision reverse in the intertemporal choice of WSI construction. Recognizing the presence of bounded rationality, particularly in terms of time preference inconsistency, a hyperbolic discounting model is constructed. The implicit subsidy, explicit subsidy, and improved explicit subsidy scenarios are simulated to analyze the decision process of individual farmers in WSI construction. The proposed methods are applied to discuss the construction of WSI within the Taocheng District, Hebei Province. The results show that: (1) The participation and stability of individual WSI construction demonstrated an increase in both the explicit subsidy and improved explicit subsidy. (2) Compared with the implicit subsidy, there was a 29.6% decrease in the number of participants who chose not to engage in WSI construction at different intertemporal choice points in the explicit subsidy scenario, and the inconsistency of choice in different intertemporal choice points decreased from 70.4% to 31.4%. (3) In the improved explicit subsidy scenario, the inconsistency of choice in different intertemporal choice points will be further reduced to 22.5%. In order to promote WSI construction for water conservation, the policy implications of the subsidy mechanism are proposed in this paper.
... Decision-making is influenced by the value of outcomes, the probability of outcomes, and the ambiguity or risk of outcomes (e.g. Kahneman et al., 1997;Kahneman & Tversky, 1979). According to a classic distinction between ambiguity and risk derived from Knight (e.g. ...
... Further, we defined the different levels of risk based on a suggestions of Rothschild & Stiglitz (1970) as the spread of potential outcomes. On the behavioral level, data confirmed classical effects of risk and ambiguity (see Ellsberg, 1961;Kahneman et al., 1997;Kahneman & Tversky, 1979;Knight, 1921). Subjects behaved significantly more cautiously when they had to decide between one high-risk option and one low-risk option. ...
Neural correlates of decisions under risk and under ambiguity have been examined for several decades. In the current study, we focus on a neglected aspect that is a potential confounding of the average risk of alternatives in a trial, the average magnitude of the outcomes, and the difference in risk between the two alternatives. We present an experimental approach to solve this problem here and explicitly separate risk and ambiguity. In the present fMRI-study with 20 participants, we created different levels of risk and ambiguity to investigate their effects on behavior and brain activation. In a first experimental block, decisions with mixed-risk options (one high-risk option paired with one low-risk option) were compared to decisions with two high-risk or two low-risk options in terms of the effects on decision-making and neural activity. The second block consisted of the same risk levels crossed with high and low ambiguity by withholding information about the probabilities of the outcomes. During mixed-risk trials participants made cautious decision significantly more often. This effect was strongest during mixed trials with high ambiguity in the second block. In addition, risk behavior of subjects was correlated with the subjective importance of the amount of potential monetary losses or wins and the related probabilities. The fMRI results revealed activation of the dorsal anterior cingulate cortex (dACC), the insula, and the orbitofrontal cortex (OFC) during mixed risk trials without ambiguity. In contrast, activation of the amygdala was specifically present during mixed-risk trials with high ambiguity.
... These studies span various disciplines, notably in finance and economics. One such work by Thaler, Tversky, Kahneman, and Schwartz emphasized the role of loss aversion in shaping risk attitudes [3]. Their findings revealed that the loss aversion coefficients were consistently higher than their risk aversion counterparts. ...
This paper thoroughly examines behavioral finance, challenging traditional financial theories by questioning investor rationality and market efficiency. Focusing on five key phenomena—loss aversion, short-term momentum, long-term reversal, framing effect, and endowment effect—the analysis relies on real-world observations to reveal how psychological biases significantly impact investor decisions and financial markets. Loss aversion, especially evident during financial crises, highlights humans' tendency to avoid potential losses rather than pursuing equivalent gains. The study explores short-term momentum and long-term reversal, challenging market efficiency theories by illustrating how past performance influences future returns. Emphasizing cognitive biases like framing and endowment effects, the paper underscores their role in diverse investment decisions and irrational asset overvaluation based on a sense of ownership. It advocates for incorporating these biases in financial models, regulations, and investment strategies, emphasizing their importance for stakeholders to navigate the financial landscape, minimize instability, and capitalize on opportunities. The research establishes a foundation for a holistic finance approach, respecting and leveraging human behavior for market stability and benefit.
... According to Thaler, Tversky, Kahneman, and Alan Schwartz (1997), "loss-aversion investors are willing to take risks when they evaluate their investments less often and investors accept higher risk when all payoffs increase to the point where additional losses are eliminated." Further, Thaler et al. (1997), explained that investors who receive regular feedback take less risk and make less money. Jeong and Hanna (2004) state that people who own riskier assets tend to be more satisfied with their financial situation. ...
This paper examines the effect of psychological factors and financial behavior on the financial well-being of individual equity investors in Sri Lanka. It draws upon the multi-theoretical linkage of social cognitive, prospect, and self-efficacy theories. The study uses survey data from 389 individual equity investors registered at the Colombo Stock Exchange. The results show that financial risk tolerance negatively impacts financial well-being, suggesting that those who are more willing to take risks have lower financial well-being. Results also show that financial behavior positively affects financial well-being. Our findings provide valuable information to the stock market participants, government, and other policymakers to understand the key determinants of financial well-being and identify the most critical areas of financial management practices to enhance the financial well-being of individual equity investors in Sri Lanka.
... During a crisis, humans often change their behaviour to account for the possible loss of financial security. As (Kahneman and Tversky, 1979;Kahneman, Knetsch and Thaler, 1991;Thaler et al., 1997) suggest, humans are by their very nature loss-avert; so, any crisis will make them increasingly loss-avert. However, as hinted by (Lo, 2013;Mateu, Monzani and Navarro, 2018), humans are also opportunists with a hint of greed, so many householders take risks to increase their wealth during a bubble or booming economy. ...
The importance of the housing market to households and the economy is paramount to monetary policies. However, there is limited literature on the behavioural factors influencing the decision-making process in the housing market. This article profoundly examines the psychological and neurological factors influencing the housing market. It reviews how cognitive and emotional influences shape the householders, both sellers and buyers, decisions in the housing market. More importantly, we review the literature on neuroeconomics (and neurofinance) to initiate an understanding of how the brain could work in the housing market. In summary, the householders' reactions to information and news are consistent with behavioural finance theories. Householders tend to underreact to news regarding the housing market and often suffer from biases and heuristics. One of the critical effects that householders suffer from is an illusion of control; this could be traced to the emotions of householders towards the house. Householders do not just show positive emotions towards the property; they fall in love with it. This strong emotional bond is one reason buyers overpay and sellers overprice. Both governments and monetary policymakers need to understand the psychology influencing the householders' decision-making process mainly because the housing market is vital to the economy.
... For example, in decision-making and foraging tasks where participants must choose to either exploit a current resource or explore alternatives, more exploratory or information-seeking behavior is observed in variable compared to stable contexts [45][46][47][48][49] and this effect is more pronounced in less predictable decision-environments [50][51][52] . Although the impact of harshness on elective flexibility is much less studied, a pronounced suppression of explorative behavior in response to risk is observed in both humans (e.g., loss-aversion bias 53 ) and nonhuman animals 54 . For example, in their recent study, Shulz et al. 55 found that in a maximization task participants made safer, less explorative choices under risky conditions. ...
Human cognition is incredibly flexible, allowing us to thrive within diverse environments. However, humans also tend to stick to familiar strategies, even when there are better solutions available. How do we exhibit flexibility in some contexts, yet inflexibility in others? The constrained flexibility framework (CFF) proposes that cognitive flexibility is shaped by variability, predictability, and harshness within decision-making environments. The CFF asserts that high elective switching (switching away from a working strategy) is maladaptive in stable or predictably variable environments, but adaptive in unpredictable environments, so long as harshness is low. Here we provide evidence for the CFF using a decision-making task completed across two studies with a total of 299 English-speaking adults. In line with the CFF, we found that elective switching was suppressed by harshness, using both within- and between-subjects harshness manipulations. Our results highlight the need to study how cognitive flexibility adapts to diverse contexts.
... Second, these decisions involve weighting the losses and gains that have an intertemporal dimension (as outcomes occur at different moments in time): current and future wealth. Research on intertemporal decisions shows that individuals tend to discount losses in the future relative to losses in the present (Thaler et al., 1997), suggesting that when financial and SEW are at risk, family members will push the potential loss into the future. As Martin et al. (2016) note, one way to achieve this is by extending the time horizon of their decisions. ...
Intermittent exporting (repeatedly exiting and reentering foreign markets) is often associated with the initial stages of internationalization. However, some small and medium-sized enterprises (SMEs), including family firms, pursue an intermittent exporting strategy beyond the initial stages. Drawing on a refinement of the behavioral agency model (BAM) and real options reasoning, we theorize that a high level of family involvement in SMEs is positively associated with intermittent exporting. We also argue that this relationship is moderated by Chief Executive Officers (CEOs) and board members with a foreign background. We test our hypotheses using a unique longitudinal dataset of Swedish SMEs in the manufacturing and retail industries.
... Furthermore, Pompian (2006) states that mental accounting refers to the activities of coding, categorizing, and evaluating financial decisions. In certain cases, mental accounting discusses how a transaction is evaluated over the time (for example regarding how often a portfolio is evaluated) and cross-sectionally (for example whether the transaction is evaluated based on its portfolio or evaluated individually) (Thaler et al., 1997;Haigh & List, 2005). ...
The Indonesian Central Securities Depository (KSEI) in 2021 revealed a significant increase in the number of capital market investors. This study aims to analyze the psychological and gender biases influencing capital market investors in making risky investment decisions, based on the theory of myopic loss aversion (MLA). The participants two groups: experienced and inexperienced investors. The experimental stage involved manipulating the groups with two types of treatment, frequent and infrequent, using a between-within-subject design with a 2 x 2 factorial structure. The results of the gender experiment showed that male and female participants in the experienced group exhibited similar levels of courage. However, in the inexperienced group, which mainly consisted of students, gender differences were observed. Men tended to be more daring and speculative in their decision-making, particularly during the pandemic. On the other hand, women tended to prioritize security in their investment choices. Additionally, the study found evidence of a “shock effect” experienced by participants during the experiment. This effect contributed to investors’ cautious decision-making, and it was also influenced by gender differences. The findings suggest Man in the inexperienced group displayed higher risk-taking tendencies compared to women, who were more focused on security when using their investment funds.
... Előbbi azt feltételezi, hogy a családi vállalkozások veszteségkerülők a szocioemocionális vagyonuk védelme érdekében, amiből következően alacsonyabb szintű a K+F beruházások aránya körükben. Ehhez kapcsolódik a rövidlátó veszteségkerülés jelensége, ami miatt a cégek általában nem a hosszú távú érdekeiket nézik, a befektetéseik rövid távra irányulnak, aminek következtében negatívan reagálhatnak a legutóbbi vesztesége-[Dokumentum címe] Baros-Tóth Ágnes ikre anélkül, hogy figyelembe vennék, hogy hosszú távon mi az előnyös a számukra (Thaler et al., 1997). A családi vállalkozások egy részére azonban mégsem a rövidlátó veszteségkerülés jellemző, mert hajlandóak nagyobb arányban befektetni a cég hosszú távú céljainak megvalósításába. ...
AbsztraktA családi vállalkozások kutatása az 1980-as években kezdődött, így viszonylag fiatal tudományterületnek tekinthető. A családi vállalkozásokkal foglalkozó kutatást már a kezdetektől a tudományos legitimáció kialakítására való törekvés jellemzi, aminek eredményeként a kutatások elméleti megalapozásához a közgazdaságtudomány meghatározó jelentőségű elméletei közül többet is integráltak a családi vállalkozás kutatásba, amelyen belül a legtöbbet hivatkozott elméletek az ügynökelmélet, az erőforrás-alapú szemlélet, a stewardship-elmélet, a szocio-emocionális vagyon elmélete és az intézményi közgazdaságtan. A szocio-emocionális vagyon elmélete azért emelendő ki a felsorolt elméletek közül, mert ez nem egy ismert közgazdaságtudományi elmélet adaptálása a családi vállalkozásokra, hanem a családi vállalkozás kutatás által kidolgozott és folyamatosan fejlesztett önálló elmélet. A tanulmány célja, hogy részletesen bemutassa a szocio-emocionális vagyon fogalmát, kialakulását és fejlődését szakirodalmi kutatás alapján. A szocio-emocionális vagyon jelentősége, hogy segítségével érthetőbbé váltak a családi vállalkozások egyedi jellemzői, különösen az a befolyás, amit a család gyakorol a vállalkozás kockázatvállalási hajlandóságára.
... Similar to the key proposition in the attentional drift diffusion model (Krajbich et al., 2010), this hypothesis assumes that gains and losses compete for limited cognitive resources, with the over-valuation of loss arising as the consequence of a more intense processing of losses than gains. The dynamic context hypothesis is consistent with the findings that loss aversion can be attenuated by attention manipulation (Sokol-Hessner et al., 2009;Thaler et al., 1997) and may even disappear when gain and loss are presented in isolation (McGraw et al., 2010). The static sensitivity and dynamic context hypotheses differ in their predictions about the neural dynamics of gain and loss valuation: The former predicts greater encoding strength for loss than for gain regardless of time, while the latter only predicts an overall bias towards loss, which may result from differences in either encoding strength or time course (Clay et al., 2017;Sheng et al., 2020;Zhao et al., 2020). ...
In human decision-making under risk, loss is typically valued more than the same amount of gain, a behavioral phenomenon known as loss aversion, which suggests that gain and loss are evaluated differently in the brain. Most previous neuroimaging studies focused on the brain regions that show differential responses to losses relative to gains. What is still largely unknown is how the neural processing of gain and loss may unfold in time and drives loss aversion. Here we designed a gambling task ideal for investigating the temporal course of the valuation process and used magnetoencephalography (MEG) to track human participants’ brain activities for valuating gain and loss. Computational modeling of participants’ behaviors implies that the gain and loss presented simultaneously can compete for cognitive resources, during which loss signals dominate the valuation process, resulting in loss aversion. Indeed, time-resolved MEG analysis reveals that the evaluation process of loss terminated later for participants with higher loss aversion than those with lower loss aversion, though the gain valuation had similar temporal courses for different participants. These results suggest that the origin of loss aversion may lie in the neural dynamics of loss processing.
... Intriguingly, competition and loss aversion proved significant challenges. While loss aversion has been found inversely related to risk-taking tendencies in behavioral economics (Thaler et al., 1997;Tom et al., 2007), its relevance in adventure recreation requires further investigation. One can see the apparent connections between risk-taking, loss aversion, and a sense of competition in adventure recreation. ...
Rock crawling, an off-road vehicle (ORV) activity for which drivers use highly modified ORVs to climb over extreme terrain and rock obstacles, is an outdoor adventure activity. This thrill-seeking outdoor activity requires specialized skills and knowledge to overcome challenges and remain engaged. This study aims to investigate the relationship between rock crawlers' motivations and the sources of challenges, as well as variations in that relationship due to the different levels of specialization among rock crawlers. A total of 377 rock crawling participants completed the online survey, with 11% self-classifying as novice rock crawlers, 46% as intermediate rock crawlers, and 43% as advanced rock crawlers. Through exploratory factor analysis (EFA), four motivation factors and seven sources of rock crawling challenges were identified. The results of canonical correlation analysis revealed positive associations between rock crawlers' motivations, including socialization, relaxation and freedom, self-expression, and sense of achievement, and the sources of challenges such as environmental uncertainty, activity difficulty, and competition in rock crawling. Furthermore, the results of multivariate analysis of variance (MANOVA) indicated variations in rock crawlers' motivations and sources of challenges across the three specialized groups. Management implications: The study aims to assist public land management agencies in integrating social science research into the decision-making process and sustainable management for off-roading on public land. To operate a sustainable rock crawling program, management should emphasize: (1) providing sufficient accom-modations and access to fulfill socialization needs while ensuring safety; (2) organizing special events or competitions to enhance rock crawlers' psychological well-being and life satisfaction; (3) executing targeted marketing campaigns to attract committed or advanced rock crawlers, thereby contributing to the local economy; and (4) advocating for clean energy consumption and regulating greenhouse gas emissions.
... There is evidence that myopic behavior may play a role in the reluctance to invest in stocks. Thaler, Tversky, Kahneman, and Schwartz (1997) provide experimental evidence that the frequency at which investment performance is presented can affect a client's propensity to invest in stocks. In the experiment, different groups of investors were compared. ...
It is important for financial planners to understand what drives risk tolerance as it directly influences the portfolio allocation preference of clients. We hypothesize that habit formation, loss aversion and investor sentiment account for significant variation in risk tolerance. We analyze average monthly scores from a widely used risk tolerance questionnaire. We find that the habit formation, loss aversion, and sentiment proxies account for -1.06%, 38.51%, and 13.21% of the variation in average monthly risk tolerance, respectively. Habit formation did not account for additional variation in average monthly risk tolerance when controlling for loss aversion and sentiment.
... This excess sensitivity to losses has been shown to induce important and pervasive biases in decision-making in areas as diverse as pension contributions, organ donation, tax payment, consumer decisions and disease prevention behaviour (O'Keefe & Jensen, 2007;Behavioural Insights Team, 2012;Cribb & Emmerson, 2016). The evidence base for loss aversion has been built largely on surveys of student populations from all over the world: Kahneman & Tversky's (1979) paper was based on surveys of Israeli, Swedish and American university students and a single special issue of the Quarterly Journal of Economics in memory of Amos Tversky contained papers based on surveys of students from the Netherlands, the UK and the USA (Bateman et al., 1997;Gneezy & Potters, 1997;Thaler et al., 1997). For the interested reader, Rabin (2003), Rabin & Thaler (2001), and Thaler (2000), celebrate the rich contributions of prospect theory to our understanding of human decision-making, while Barberis (2013) provides a more recent assessment of this literature. ...
This paper applies the well-known cognitive bias of loss aversion from behavioural economics to student decisions over engagement with mathematically demanding coursework. This bias is shown to predict behaviour that is consistent with mathematics anxiety in a dynamic model of student engagement. It is shown that these forces can imply polarization in student outcomes with some students chronically disengaged in a low-attainment equilibrium, in the absence of any countervailing pedagogic interventions. However, the model illustrates that chronic disengagement is not necessarily equivalent to chronic apathy. Rather, students for whom the short-term cost of failure looms large are shown to be at heightened risk of disengagement. The model is used to understand and evaluate various elements of the mathematics anxiety literature including the role of formative assessment, the fixed and growth mindset models, the efficacy of task-oriented achievement goals, the cognitive interference and motivation enhancement models of test anxiety, the provision of remedial classes and technology-enhanced solutions to learning and assessment.
... For instance, research in behavioural accounting and finance, considering the effect of heuristics and biases in those decision-making processes, can be informed by understanding psychology research. A lot of research has studied non-rational decisions and theoretical concepts such as loss aversion, drawing on findings initially from psychology (see Thaler et al. (1997) and related work). In this case one size does not fit all when thinking about theoretical explanations for observed empirical phenomena. ...
... 3) agents are short-sighted in their preferences related to loss aversion [37]. Hence, we may say that now we have a set of prerequisites that allows to analyze various CEO investment decisions depending on the personal traits of such CEOs and their cultural background. ...
This paper conducts a comprehensive literature review of the factors influencing the emergence of the CEO investment horizon problem – a preference for short-term investments over long-term ones. The root cause of this CEO issue, as in-dicated in existing literature, is often attributed to the CEO's personal risk attitude, shaped by factors like age, tenure, and cultural background.Numerous sources contributing to the short-term investment problem in public companies are described in the current academic literature. Prominent among these determinants are the challenges of quarterly reporting, the association of corporate performance with short-term metrics, market pressures, and the company's specific risk profile. A study by McKinsey & Company, focused on the short horizon problem, demonstrates that companies inclined toward short-term investments exhibit weaker fundamentals and performance. The consulting firm Ernst & Young has introduced the Long-term Orientation Index, offering a basis for cross-country comparison of decision horizons. In 2010, Antia and colleagues introduced a metric for measuring CEO decision horizons, which relies on CEO personal characteristics. Despite these efforts, a comprehensive literature review addressing the specificity of the CEO investment horizon problem and its dis-tinctions from the broader corporate investment horizon problem has been absent.This paper not only investigates the initial empirical exploration of the short investment horizon problem but also raises questions about its cross-country manifestations, its potential correlation with economic crises, and the relevant personal traits of CEOs for its study. Finally, the paper proposes various strategies to mitigate the CEO investment horizon problem within companies.
... Thaler et al. pointed out that the external environment also affects investors' degree of loss aversion [4]. Barberis et al. combined loss aversion with narrow framing to explain the phenomena of stock returns [5]. ...
Loss aversion is an important psychological phenomenon. Adding loss aversion to the category of behavioral economics can well explain many phenomena that cannot be explained by general models. This paper reviews some relevant studies showing the application of loss aversion in the stock markets, real estate markets and COVID-19, and finds that loss aversion does influence people's decisions and the market as a whole. In the stock market, the combination of narrow framing and loss aversion leads to a shorter valuation period and investors reluctance to sell the stocks. Loss aversion in the real estate market will drive house sellers to set a higher price, and investors with more experience are even more loss aversion than inexperienced investors. In the context of COVID-19, emergency orders can improve their profits, and the time of blockade can be extended under the loss framing. In general, loss aversion makes people more reluctant to give up what they have, leading to higher trading prices and other problems. Thus, this paper corroborates that loss aversion has more explanatory power than general economic models in some aspects. Further analysis is needed as to how loss aversion can be used to predict and modify people's behavior.
... Behavioral finance studies have shown that investors are loss averse, meaning they are more sensitive to the negative changes to their wealth than gains (Thaler, Tversky, Kahneman, and Schwartz, 1997). In the case of loss aversion, utility function is steeper for losses than gains. ...
We evaluate the fit of target-date funds (TDFs) as the main retirement savings instrument for the utility-maximizing investor who becomes more risk averse as she gets older. Using bootstrapping simulations, we show that TDFs can provide higher expected utility than the alternative lifestyle strategies. With loss aversion incorporated in the model, we still find that the optimal lifecycle strategy over time leads to higher expected utility than the best lifestyle strategy. Therefore, TDFs are preferable to the utility-maximizing investor. However, lifecycle strategies are not one-size-fits-all solution and investor’s risk tolerance has to be considered when selecting TDF funds.
... The term myopia used for such frequent measures towards portfolio evaluation (Lee & Veld-Merkoulova, 2016). Myopic loss aversion is the combination of greater sensitivity to losses than to gains, investors who display myopic loss aversion will be more willing to accept risks if they evaluate their investments less often (Thaler, Tversky, Kahneman, & Schwartz, 1997). The myopic loss aversion has two behavioural principles (1) loss aversion (2) mental accounting (Haigh & List, 2005). ...
The main goal of this research is to discover the antecedents behind the loss-averse biased behavior of shareholders in the Pakistan Stock Exchange (PSX) and to develop scale on it to operationalize this research in the future. Loss aversion a simple term which states that loss looms larger than gains. The preliminary part of research contains semi-structured interviews taken from the professionals of stock exchange. The second part contains the floatation of self-established scale and to put on Exploratory Factor Analysis (EFA) on the outcomes for the lessening of overloading items. The third part contains the floatation of polished scale with lesser sample size as liken to previous floatation of scale to check the inter-item correlation among items so as to get further polished scale. The forth part contains the floatation of polished scale with lesser sample size as liken to previous floatation of scale to check the consistency of factors, association among factors, and cause and effect connection among factors. The last part contains the floatation of more polished scale with lesser sample size as liken to previous floatation of scale to ratify the factors for scale through Principal Component Analysis (PCA). By exploring and confirming the antecedents of loss-averse bias of investors in the Pakistan Stock Exchange, the controlling body of stock exchange (Security and Exchange Commission of Pakistan-SECP) may control the loss-averse bias of persons by providing workshops on it, which may lead to well-organized stock exchange and overall economy.
... Our estimates cannot determine whether or not individuals are risk-taking or risk-averse, we only observe risk attitudes changes relative to policy recommendation. This adjustment of behavior can be interpreted by myopic loss aversion (Thaler et al. [29]), where evaluation on prospects and associated risk attitudes changes cause preference reversal and evolution in behavior as new information and learning emerge (Berg et al. [7]). Put into the context of the more micro level literature, such as Czeisler et al. [12], Goolsbee and Syverson [14], and Alfaro et al. [2]; our results suggest that for the most states the lack of short run convergence to policy recommendations is due to risk attitudes changes. ...
... Similarly, myopic loss aversion occurs when an investor feels more hurt by the losses than profits and tends to frequently evaluate and monitor his or her investment results. Based on an experimental approach, Thaler et al. (1997) concluded that investors who received more frequent feedback on the performance of their investments were less likely to take risks and therefore forgo an appreciation in the value of their investments. The aversion to shortterm losses suggests that excessive information and performance monitoring of an investment portfolio is associated with higher risk aversion and lower portfolio performance. ...
This paper examines the relationship between the Big five personality traits, socio-economic characteristics, and the investment decisions of individuals, with a focus on the decision-making of young adults. The empirical analysis was carried out using data obtained from a survey which identified the young adults’ personality traits, degree of risk aversion and preferred investment strategy. The estimation results show that individuals who are more agreeable have a higher degree of risk aversion. However, men and individuals with higher income are less risk averse, while older individuals in our sample tend to have a higher degree of risk aversion. The estimation results also show that certain personality traits and socio-demographic characteristics significantly affect the choice of individuals’ choice of preferred investment strategy. More extroverted individuals in our sample were identified as more likely to diversify their investment portfolio. However, we find that individuals more open to new experiences are more conservative in their investment decisions and diversify their investment with a lower probability. Considering individual socio-economic characteristics, men are more likely to diversity their investment portfolio and choose a less conservative investment strategy than women. Furthermore, marital and employment status were found to be significantly related to a preference towards a conservative investment strategy.
... A related category of results concerns investment games (Gneezy and Potters 1997;Thaler et al. 1997;Bellemare et al. 2005;Gneezy et al. 2003;Haigh and List 2005). The general nding is that people tend to invest less conservatively, i.e. they take on more risk, when they are informed about the outcomes of their decisions only infrequently. ...
Standard economic models view risk taking and time discounting as two independent dimensions of decision making. However, mounting experimental evidence demonstrates striking parallels in patterns of risk taking and time discounting behavior and systematic interaction effects, which suggests that there may be common underlying forces driving these interactions. Here we show that the inherent uncertainty associated with future prospects together with individuals’ proneness to probability weighting generates a unifying framework for explaining a large number of puzzling behavioral findings: delay-dependent risk tolerance, aversion to sequential resolution of uncertainty, preferences for the timing of the resolution of uncertainty, the differential discounting of risky and certain outcomes, hyperbolic discounting, subadditive discounting, and the order dependence of prospect valuation. Furthermore, all these phenomena can be accommodated by the same set of preference parameter values and plausible levels of inherent uncertainty.
... However, this experiment used a withinsubjects design, where it is possible that the ability to compare the two made the ranges which included a loss seem less desirable. This would also explain why we no longer see differences in investments between precise and range forecasts that were apparent in Experiments 1 and 2. Nevertheless, this remains a highly plausible effect in a between-subjects design given the well evidenced loss aversion effect (Kahneman & Tversky, 1979;Thaler et al., 1997;Willman et al., 2002). ...
Consumers are often shown investment returns with high levels of precision, which could lead them to misunderstand the inherent uncertainty. We test whether consumers are drawn to precision-that is offset the uncertainty in investment decisions by over-relying on precise numerical information. Five incentivized experiments compared decisions when expected growth is presented in precise forecasts as opposed to ranges. Consumers are more likely to prefer and invest more in precise forecasts when they are evaluated jointly with ranges and when the range features a potential loss. Under these circumstances, precise forecasts give consumers more confidence to invest. This effect holds when consumers are told investment returns are uncertain. On the other hand, experiencing discrepancies between expected and actual growth dissipates the preference for precise forecasts. We identify conditions under which consumers are more likely to favor precise forecasts and how this could be avoided if necessary. (PsycInfo Database Record (c) 2023 APA, all rights reserved).
... In the real financial world, risk factors are seldom known ex-ante. In addition, many academic investigations in the area have found examples of irrational behavior and recurrent errors in judgment (see among others DeBondt and Thaler, 1990;Shiller, 1995;Thaler et al., 1997;Kahneman, 2011;Henderson, 2012;Hirshleifer, 2014). A major implication of the behavioral literature is that investments are evaluated not only on the basis of their objective risk but also may be subject to what can be broadly called "misvaluation" due to psychological factors (Hirshleifer, 2001). ...
This report delves into the fascinating world of psychological biases and their profound impact on individual investment decisions and stock market returns. Drawing insights from the field of behavioral finance, it explores how the human mind's tendencies and cognitive quirks can lead investors astray from rational, profit-maximizing choices. The report begins by setting the stage for understanding the significance of this topic, emphasizing the importance of exploring the interplay between psychology and investing. It then dives into the core concepts, theories, and key factors that shape behavioral finance, providing a solid foundation for the subsequent analysis. A crucial aspect of the report is the in-depth examination of specific psychological biases, such as overconfidence, loss aversion, and confirmation bias, and how they manifest in stock market investing. The report presents empirical evidence, case studies, and real-world examples to illustrate the tangible effects of these biases on investment performance and personal returns. Recognizing the need for practical solutions, the report offers strategies and techniques for mitigating the influence of psychological biases. It equips investors with the tools and knowledge necessary to make more informed, rational decisions, ultimately enhancing their chances of achieving their financial goals. By the end of the report, readers will have a comprehensive understanding of the complex interplay between human psychology and investing, as well as a roadmap for navigating the challenges posed by behavioral biases. The report concludes with a summary of key insights and recommendations for future research directions, solidifying its position as a valuable resource for investors, financial professionals, and scholars alike.
This paper makes a novel attempt to analyse the mental accounting process through the eyes of financial accounting. Financial accounting is pretty familiar in the accounting and overall commerce domain. But still, mental accounting is not much familiar among the masses. Financial accounting is a process that is employed by those companies which are supposed to follow the process by law. But the interesting fact is that every person is knowingly or unknowingly going through the mental accounting process in their day-to-day life. So, the paradox is that people are knowingly or unknowingly people involved but they are not familiar with that. The awareness of mental accounting can put people into an uncomfortable position as they are comfortable in feeling they are rational. Even though it is said unfamiliar to many, it has got a rich existing literature in its mother field of behavioural economics.
Are banks sensitive to risk and reward in following global corporate transparency rules? Using a worldwide field experiment, this study evaluates competing predictions from expected utility, behavioralist, and institutionalist accounts. We incorporated a dozen companies around the world to make over 15,000 email solicitations asking for corporate accounts from 5000 of the world's internationally connected banks. Treatments randomize the risk profiles of different companies—by their countries’ association with corruption, terrorism, and tax evasion—and vary rewards by stating differing amounts of business revenues. The outcomes are the rates at which banks offer accounts and comply with rules on customer identification. The results suggest that banks are moderately responsive to risk—though not reward—but the magnitude of the effects is small, providing mixed evidence for conventional models and suggestive support for institutionalist accounts.
Investors need not be rational for markets to be efficient. The axiom of efficient market hypothesis that it is not possible to earn excess profits because the available information gets factored in instantaneously fell flat due to influence of human behavior on the investment process. Exuberance of investors escalates asset values unduly on the back of financial irrationality. The intersection of human behavior and the investment decisions has since evolved as "behavioral finance." Research demonstrates that investment decision-making process is more human than analytical, owing to behavioral biases. Recent studies in prospect theory and heuristic decision-making process focused more on investor behavior causing market anomalies. At a time when irrational behavior is demonstrated not only in security markets but also in other markets such as property, bullion and commodities, this paper explores the contemporary research in behavioral finance.
Beklenti teorisi, bireylerin kararlarında psikolojik etkenlerin de etkili olduğunu iddia etmektedir. Beklenti teorisi perspektifi ile gerçekleştirilen ampirik çalışmalarda vergi uyumunu etkileyen ekonomik ve mali faktörlerin yanında ekonomi dışı faktörlerin de etkili olduğu gösterilmektedir. Mükelleflerin vergiye karşı tutum ve davranışlarında psikolojinin de önemli olduğunu gösteren çok sayıda davranışsal maliye çalışması gerçekleştirilmiştir. Bu çalışmada Beklenti teorisi kapsamında vergi uyumunu etkileyen faktörlerin belirlenmesi amaçlanmıştır. 817 katılımcıdan anket yoluyla elde edilen veriler Tobit regresyon modeli ile analiz edilmiştir. Çalışmadan elde edilen bulgular, beklenti teorisinin varsayımlarının vergi uyumunda etkili olduğunu ve kayıptan kaçınma oranı yüksek olan bireylerin, düşük olanlara göre daha az vergi ödemek istediklerini göstermektedir.
Kahneman ve Tversky, 1979 yılında yayımlanan çalışmalarında beklenti teorisini ortaya koymuşlardır.
Beklenti teorisi, rasyonel karar verme konusuna yeni bir bakış açısı getirmiştir. Rasyonel bireyin aynı
miktarda kayıp ile kazanca eşit değer atfetmesi beklenmektedir. Ancak deneysel çalışmaların bulguları bu
beklentiyi teyit etmediği gibi tersini göstermektedir. Beklenti teorisi kapsamında ele alınan konulardan
birisi olan kayıptan kaçınma, aynı miktardaki kayıp ile kazancı karşılaştıran bireyin bu kayba, kazanca
göre daha fazla değer atfetmesidir. Kayıptan kaçınma, ekonomik analizlerde giderek daha fazla ilgi gören
önemli bir psikolojik kavramdır. Mükelleflerin vergiye karşı tutum ve davranışlarında psikolojilerinin
önemli bir yer edindiğini ortaya koyan deneysel çalışmalar davranışsal maliye alanına yeni bir yön
vermiştir. Bu çalışmanın amacı, davranışsal maliye perspektifinden kayıptan kaçınmayı etkileyen
faktörlerin tespit edilmesidir. Anket tekniği ile 817 katılımcıdan veri toplanmıştır. Kolayda örnekleme
yöntemiyle elde edilen verilerin analizinde Logit regresyon modelinden yararlanılmıştır. Tversky ve
Kahneman tarafından 2,25 olarak tahmin edilen kayıptan kaçınma oranı 4,50 olarak tahmin edilmiştir.
Bulgularımıza dayalı olarak bireylerin risk düzeyi arttıkça kayıptan kaçınma oranının azaldığı ve
yaşadıkları bölgenin nüfusu arttıkça da kayıptan kaçınma oranının arttığı iddia edilebilir
Wie treffen wir mutigere Entscheidungen, um zukunfts- und konfliktfähig zu werden? Und warum ist das so schwer? Im Angesicht der Situation Deutschlands und dem Agieren der Regierung in der Frühphase des Ukrainekriegs möchten die Beiträger*innen ein Zeichen für mehr Mut setzen - in der Politik wie in der Gesellschaft, in Krisenzeiten wie im Alltag. In elf pointierten Essays widmen sie sich dieser vernachlässigten Tugend und betrachten ihre verschiedenen Facetten und Voraussetzungen. Zudem leuchten sie die Rahmenbedingungen für mutigere Entscheidungen und ein mutigeres Handeln aus - bis hin zu den individuellen Persönlichkeitsmerkmalen dessen, was Mut ausmacht.
In the complex arena of personal finance, the influence of behavioral biases on financial decision-making stands as a formidable force. This chapter delves deep into the world of behavioral biases, shedding light on their profound impact on personal finance. Overconfidence bias, confirmation bias, anchoring bias, loss aversion, regret aversion, and the emotional pendulum of fear and greed are explored in detail. These biases often lead individuals astray from rational, optimal financial choices, manifesting as excessive risk-taking, selective information gathering, overreliance on reference points, aversion to losses, decision paralysis, and impulsive market reactions. However, this chapter is not just an exposé of cognitive and emotional pitfalls; it also offers practical strategies to counteract these biases. From diversifying information sources to embracing uncertainty, readers gain insights into how to navigate the intricate maze of personal finance with greater awareness and resilience. Real-life case studies provide concrete examples of these biases in action, offering invaluable lessons in recognizing, addressing, and mitigating their influence. By understanding these biases and their effects, individuals can embark on a journey towards more informed, rational, and ultimately successful financial decision-making
Artificial intelligence (AI) is increasingly used in medicine, making it one of the largest and fastest-growing fields in which AI is applied. While some AI-based applications are already outperforming experts regarding diagnostic accuracy, patients' trust in AI is still comparatively low. Given the tremendous potential of medical AI applications, understanding what influences patients' and doctors' perceptions of medical AI is of utmost importance. To this end, we assessed for N = 750 participants (N = 684 laypeople and N = 66 medical experts) whether medical expertise and perceived causability, that is the transparency, efficiency and satisfaction with which the AI is perceived, are related to the perception of risks and benefits in three different medical AI scenarios. Benefit perception increased with higher perceived causability but was unrelated to medical expertise. On the other hand, risk perception increased with higher medical expertise and decreased with higher perceived causability. Therefore, when introducing and using medical AI applications in the treatment of patients, it is essential to sensitize both patients and medical experts to the different perceptions. Such measures can be an important prerequisite for increasing AI acceptance in medicine.
This article explores the concept of anchoring bias in financial decision-making. Anchoring bias refers to the tendency for individuals to rely too heavily on an initial anchor when making judgments or decisions, even if the anchor is arbitrary or irrelevant. The article defines anchoring bias, discusses its effects on investment decisions, pricing and valuation decisions, and risk assessment and management. Strategies for recognizing and reducing the impact of anchoring bias are explored, including awareness and reflection, seeking diverse perspectives, considering multiple anchors, utilizing decision-making tools, and encouraging independent thinking. The role of education and training in minimizing anchoring bias is discussed, as well as the importance of diversification and independent analysis in decision-making. By understanding and addressing anchoring bias, individuals can make more rational and unbiased financial decisions.
We integrate behavioral agency research and the five‐factor model of personality to re‐visit investment analysts' efficacy as a mechanism for reducing agency costs. We highlight the role of personality in shaping how CEOs respond to analyst recommendations, leading to boundary conditions for the efficacy of analysts as external monitors. We theorize that the extent to which a CEO perceives a threat from more positive analyst recommendations is contingent upon their personality, which shapes their subjective interpretation of the recommendation and their use of income‐increasing earnings management in response. Our findings suggest that personality is critical to understanding how CEOs respond to external monitors and the agency costs associated with the positive analyst recommendations.
The convoluted world of finance is filled with a number of irrationalities that the science of behavioral finance seeks to explain by bringing cognitive biases. Cognitive bias is a systematic pattern of deviation from rationality and is caused by limited cognitive capacities. By specifically analyzing Chinese investors, the paper aims to identify common cognitive biases exercised by high net-worth Chinese investors that lead to insufficient diversification and naive diversification in portfolio construction and to explain the following scenarios that are not commensurate with classic financial theories: the reason why investors prefer rule of thumbs instead of complete diversification; or when they do diversify, they simply takes N instruments and consider it done; the fact that people stick with a chosen stock or fund even when their prospects are not favored and other opportunity has arisen; and that investors from the same social background as a whole might have experienced certain preferences. And finally, when the cognitive biases are exercised by large enough of a population, stock market might suffer abnormal variances from it. The answers to these questions are studied by qualitative research methodology in this paper, narrative inquiry and inductive approach, to generalize and conclude to observed examples.
The aim of this study is to provide an understanding regarding the investor's situation of loss-aversion and stress during investment decisions in stock market, and the use of various mathematical models (game theories) to eliminate those situations. The objectives of this study are to know about the irrationalities in investor's behavior in stock market, due to stress and loss-averse behavior of investors, and find-out the ways to deal with these behaviors. Qualitative research style used to gather data from the participants of the study. Semi-structured interviews designed to know about the experience and thoughts of each respondent in detail. A sample of 16 experienced stock marketers from Pakistan and USA selected for this study. The study found the specific kind of tensed and biased investor's behaviors in the market, and found their solutions. This study obviously highpoints the ways to deal with stress and loss-averse behavior through mathematical analysis and some other suggestions. Jel Classifications: C7, G02, H54.
Beklenti teorisi, bireylerin kararlarında psikolojik etkenlerin de etkili olduğunu iddia etmektedir. Beklenti teorisi perspektifi ile gerçekleştirilen ampirik çalışmalarda vergi uyumunu etkileyen ekonomik ve mali faktörlerin yanında ekonomi dışı faktörlerin etkili olduğu gösterilmektedir. Mükelleflerin vergiye karşı tutum ve davranışlarında psikolojinin de önemli olduğunu gösteren çok sayıda davranışsal maliye çalışması gerçekleştirilmiştir. Bu çalışmada Beklenti teorisi kapsamında vergi uyumunu etkileyen faktörlerin belirlenmesi amaçlanmıştır. 817 katılımcıdan anket ile elde edilen veriler Tobit regresyon modeli ile analiz edilmiştir. Çalışmadan elde edilen bulgular, beklenti teorisinin varsayımlarının vergi uyumunda etkili olduğunu ve kayıptan kaçınma oranı yüksek olan bireylerin, düşük olanlara göre daha az vergi ödemek istediklerini göstermektedir.
EXECUTIVE SUMMARY:
For a National Society to be well-functioning in its negotiations with decision makers in state government, it needs to have a coherent, unambiguous strategic direction. To encourage the National Society to speak with one voice, this strategy is generally written down in its strategic plan. The plan itself, however, can quickly become an obsolete document unless discussions and negotiations result in commitment to the plan, with all decision-makers in the National Society understanding these commitments. The strategic planning process endeavours to do this.
In 2011, Afghanistan’s National Society, the Afghan Red Crescent Society (ARCS), needed to update its strategic plan in line with the IFRC Strategy 2020 (IFRC, 2010). In essence, Strategic Plan 2012-2015 (ARCS, 2011) was the written expression of the strategic planning process that was carried out during August and September 2011 - a process in which ARCS made decisions on where it wanted to be and why, and how it was going to get there. The specific reasons for developing such a plan, however, were not immediately apparent to the majority of staff (apart from that it was mandatory to have one), even those at senior level. Identifying the reasons for planning and how to approach the process therefore played a significant role in developing the final document.
As strategic plans are generally functional documents which provide little information on the process that formed them (thus limiting the applicability of textual discourse analysis), this paper focuses on the strategic planning process. Furthermore, as strategic planning often involves a series of high-level closed meetings held primarily to update the previous plan, this paper is unusual as it also illustrates the diplomacy required to build a policy environment for a plan that also included organisational restructuring. Essentially, this paper attempts to show how humanitarian diplomacy can, and often needs to be applied to Red Cross Red Crescent (RCRC) National Societies during strategic planning in order to affect positive changes.
The role of facilitator as a humanitarian diplomat is discussed and it is considered how modifying the mode of discourse in an organisation can affect the power relations to encourage a more inclusive approach to developing strategies. A situational analysis prior to the process, and a survey at the start of the process are both shown to inform how the strategic planning sessions were conducted. Quiet diplomacy and a series of open communicative tasks based on social constructivist theory was applied to support the creation of a shared reference framework that
encouraged cooperation, rather than competition, between members of the strategic planning committee. Some of the techniques used in sessions, which are commonly used in classroom teaching, are presented. An evidence-based logos approach to organisational restructuring , which was used to develop strategic goals on which the mission and vision of ARCS is now based, is evaluated, highlighting the need to use a variety of tools from the humanitarian toolbox when dealing with complex decision-making processes.
İktisadın temel konusu olan insan ana akım iktisat teorilerinde homoeconomicus olarak tanımlanmakta ve ekonomik insanın varsayımlar altında her zaman rasyonel davrandığı, kararları ile ilgili tam bilgiye sahip olduğu, faydasını maksimize edecek kararlar verdiği kabul edilmektedir. Böylece insanların iktisadi hayatta sınırsız istekleriyle kıt kaynakların olduğu bir dünyada, tercihler arasında hep aynı kararı vermesi beklenmektedir. Fakat hayatının her aşamasında tercihleri arasında bir karar problemi ile karşı karşıya kalan insan, ana akımın varsaydığı gibi her zaman beklenen kararlar vermeyebilmektedir. İnsan psikolojik bir canlı olarak tercihleriyle ilgili elde edebildiği bilgilerle sezgileri, duygusal ve bilişsel önyargıları, sosyal çevresi, kültürü gibi daha birçok faktörün etkisi altında beklenenden farklı kararlar verebilmektedir. Böylece davranışsal yaklaşımla, ana akımın rasyonalite ve fayda kavramlarının yerini psikolojik, duygusal, sezgisel, sosyal, kültürel faktörler almakta, insan psikolojisi ön plana çıkmaktadır. İnsanların pek çok faktörden etkilenebildiği göz önüne alınarak sınırlı rasyonel davranabildiği, kararlarında her zaman faydasını maksimize edecek objektif kararlar vermesi beklenirken farklı önceliklerle, anlık hazzını ön plana çıkaran subjektif kararlar verebildiği kabul edilmektedir. Dolayısıyla davranışsal yaklaşım, farklı bir bakış açısı getirerek, ana akımın iktisadi hayattaki insanı açıklama gücünü artırmaktadır. Çalışmanın amacı da insan davranışının ana akım iktisattan davranışsal iktisada olan süreçteki önemli noktalarını literatür taraması ile bir araya getirerek davranışsal yaklaşımın bakış açısıyla iktisadi hayattaki insanı açıklamaktır.
Contrary to theoretical expectations, measures of willingness-to-accept greatly exceed measures of willingness-to-pay. This paper reports several experiments that demonstrate that this "endowment effect" persists even in market settings with opportunities to learn. Consumption objects (e.g., coffee mugs) are randomly given to half the subjects in an experiment. Markets for the mugs are then conducted. The Coase theorem predicts that about half the mugs will trade, but observed volume is always significantly less. When markets for "induced-value" tokens are conducted, the predicted volume is observed, suggesting that transactions costs cannot explain the undertrading for consumption goods. Copyright 1990 by University of Chicago Press.
Economics can be distinguished from other social sciences by the belief that most (all?) behavior can be explained by assuming that rational agents with stable, well-defined preferences interact in markets that (eventually) clear. An empirical result qualifies as an anomaly if it is difficult to "rationalize" or if implausible assumptions are necessary to explain it within the paradigm. Suggestions for future topics should be sent to Richard Thaler, c/o Journal of Economic Perspectives, Graduate School of Business, University of Chicago, Chicago, IL 60637, or [email protected]
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Decision makers have a strong tendency to consider problems as unique. They isolate the current choice from future opportunities and neglect the statistics of the past in evaluating current plans. Overly cautious attitudes to risk result from a failure to appreciate the effects of statistical aggregation in mitigating relative risk. Overly optimistic forecasts result from the adoption of an inside view of the problem, which anchors predictions on plans and scenarios. The conflicting biases are documented in psychological research. Possible implications for decision making in organizations are examined.
This paper studies the implications for general equilibrium asset pricing of a class of Kreps-Porteus nonexpected utility preferences characterized by a constant intertemporal elasticity of substitution and a constant, but unrelated, coefficient of relative risk aversion. It is shown that relaxing the parametric restriction on tastes imposed by the time-additive expected utility specification does not suffice to solve the Mehra-Prescott (1985) equity premium puzzle. An additional puzzle — the risk-free rate puzzle — emerges instead: why is the risk-free rate so low if agents are so averse to intertemporal substitution?
Restrictions that a class of general equilibrium models place upon the average returns of equity and Treasury bills are found to be strongly violated by the U.S. data in the 1889–1978 period. This result is robust to model specification and measurement problems. We conclude that, most likely, an equilibrium model which is not an Arrow-Debreu economy will be the one that simultaneously rationalizes both historically observed large average equity return and the small average risk-free return.
Does the period over which individuals evaluate outcomes influence their investment in risky assets? Results from this study
show that the more frequently returns are evaluated, the more risk averse investors will be. The results are in line with
the behavioral hypothesis of “myopic loss aversion,” which assumes that people are myopic in evaluating outcomes over time,
and are more sensitive to losses than to gains. The results have relevance for the equity premium puzzle, and also for the
marketing strategies of fund managers.
Two core meanings of “utility” are distinguished. “Decision utility” is the weight of an outcome in a decision. “Experienced
utility” is hedonic quality, as in Bentham's usage. Experienced utility can be reported in real time (instant utility), or
in retrospective evaluations of past episodes (remembered utility). Psychological research has documented systematic errors
in retrospective evaluations, which can induce a preference for dominated options. We propose a formal normative theory of
the total experienced utility of temporally extended outcomes. Measuring the experienced utility of outcomes permits tests
of utility maximization and opens other Unes of empirical research.
We develop a new version of prospect theory that employs cumulative rather than separable decision weights and extends the theory in several respects. This version, called cumulative prospect theory, applies to uncertain as well as to risky prospects with any number of outcomes, and it allows different weighting functions for gains and for losses. Two principles, diminishing sensitivity and loss aversion, are invoked to explain the characteristic curvature of the value function and the weighting functions. A review of the experimental evidence and the results of a new experiment confirm a distinctive fourfold pattern of risk: risk aversion for gains and risk seeking for losses of high probability; risk seeking for gains and risk aversion for losses of low probability. Copyright 1992 by Kluwer Academic Publishers
Risk Aversion or Myopia: The Fallacy of Small Numbers and Its Implications for Retirement Savings
- Shlomo Benartzi
- Richard H Thaler