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Understanding Loss Aversion: Physiological and Psychological Responses

Neelesh Kabra | Aditya Birla World Academy |


How humans make decisions in the face of uncertainty, a topic that has been researched by psychologists and economists for centuries. Almost four decades ago a framework to navigate this problem was introduced: the prospect theory (Kahneman & Tversky, 1979). Tversky and Kahneman conducted a 2 phased study proving that people hate losing. In phase 1 people were given the choice of either having a 80% chance of getting $4000 or a 100% chance of getting $3000. Hence, everyone chose getting $3000 instead of $3200 showing that people prefer certainty. In phase 2 people were given the choice of a 80% chance of losing $4000 or a 100% chance of losing $3000 and majority of the respondents chose option 1 even though the expected outcome is losing $3200. This portrays the idea that people are happier losing more money instead of a guaranteed loss. Therefore, loss aversion is encapsulated in a simple expression as “losses loom larger than gains”. The question of what really is the source of loss aversion has dawned on many researchers over the years. Loss aversion is mainly based on its, omnipresence and its variance, dual-sided response to potential or actual loss and gains.


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