loss aversion

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Says Psychology Today.

One advantage is obvious: Buyers scanning listings online usually set a minimum and maximum price. These are round numbers (often chosen from a menu on the listing site). In the example above, a buyer whose maximum price was $1 million would see a house listed at “$999,000 to $1,194,876,” but not a house listed at a single price higher than a million. (Of course, this depends on listing sites being able to handle price ranges.)

Another advantage of this trick is simple confusion. Just about everyone knows that a listing price of $X typically signals that the seller is willing to accept a good deal less than $X. In this market, few sane buyers are going to offer list price. Having two prices upsets this comfortable strategy. Do you offer the low price of the range? Less than the low price? Or do you make an offer somewhere in the range? Maybe you really, really want the house and want to make a preemptive offer. Do you offer the high price?

This suggestion still doesn’t get around the problem inherent in the behavioral economics diagnosis of the current housing market. Loss averse sellers don’t want to sell a property for less than they paid for it, or less than what they think it’s worth based on peak bubble prices. Whether she picks a range or a single price, the seller has to overcome the psychological hurdle or realizing that the value today isn’t the value yesterday.

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We’ve written about the potential for using social norms to decrease tax evasion. Armenia is turning to lotteries (whose attraction is explained by Prospect Theory). Given the relative weakness of the state in Armenia, compared to say, the U.S., an innovative use of lotteries might be a good option.

Armenia is offering thousands of dollars in lottery prizes to consumers who take receipts for their purchases to try to tackle rampant tax evasion in the former Soviet republic.

The initiative began on Jan. 1 and the first prizes will be awarded this month, after authorities said the threat of prosecution had failed to encourage shopowners and market sellers to install cash registers and provide receipts.

“It’s no secret that not many people give receipts in Armenia,” said Armen Alaverdyan, deputy head of the State Revenue Committee.

Hat tip: Brian Stoner

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Erel Avineri of the Centre for Transport & Society looks at traffic from the perspective of a Human, not an Econ. Standard economic models of people seem to do a poor job anticipating what people do on the road. Using models from behavioral economics and psychology, Avineri is interested what influences our boundedly rational travel behavior. What kind of feedback might change it? What effect do our interactions with others on the road have? According to his web site, he is “exploring how to change travellers’ behaviour in a way that does not limit their freedom of choice (for example by ‘nudging’).” In some interesting research, he applied the lessons of loss aversion to everyday decision making by travelers. We asked Avineri to share his insights with Nudge blog readers.

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Tyler Cowen poses the following question about stocks, and what he says used to be the conventional behavioral economics answer.

Let’s say you bought two stocks last year. One has tanked and looks likely to fall further. One has gone up and you expect it to keep rising. (Hey, it’s not completely impossible.) Which are you more apt to sell?

Behavioral economists used to think they knew the answer: neither. Studies have shown that people tend to value things more – whether shirts, stereos or stocks – once they own them, no matter what has happened to their actual worth. This phenomenon is called the endowment effect. If it were the only psychological factor at work, you’d be reluctant to sell both losers and winners simply because they’re already tucked into your portfolio.

Cowen’s story is incomplete, and therefore unfair, even to old behavioral economists. In the scenario Cowen describes, two biases, each reinforcing the other, would be in effect: The endowment effect and loss aversion. The endowment effects for both stocks (assuming you bought them at the same price) would cancel each other out, but this would not necessarily mean investor paralysis. For more than twenty years, behavioral economists have been citing something called the disposition effect, which is an implication of prospect theory and the component of loss aversion). The status quo purchase price serves a reference point. Gains and losses are perceived relative to some other aspirational level different from the status quo – say, what you thought the stock would rise to. As the winner is closer to this aspiration, you, as the investor, become more risk-averse and therefore more likely to sell it, while holding on to the loser in the hopes of a roaring comeback, even one with a small probability.

But this isn’t the only explanation for identical behavior. An alternative is a commonly mistaken belief among average investors that stocks will revert to their mean. Stocks that have risen will fall; stocks that have fallen will rise. This story also predicts the selling of winners on the expectation that it will fall. Yes, Cowen’s scenarios says you, the ordinary investor, would expect the winning stock to keep rising. Old behavioral economics says you’d be quite extraordinary for believing this. Both of these potential explanations are laid out in Terrance Odean’s classic paper “Are Investors Reluctant to Realize Their Losses?” His data does allow him to distinguish which of the two stories makes more sense.

Addendum: Cowen’s column is actually an appreciation of a paper by Nicholas C. Barberis and Wei Xiong with yet another explanation for why investors sell winners and hold onto losers: That it’s the pleasure of actual (or what stock traders would called realized) gains – the good feeling you get from making a seemingly smart decision – and the pain of actual losses that leads to selling winners. Read the full paper.

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In July, Hart/Newhouse, the polling firm behind the NBC News/Wall Street Journal poll, included a pair of questions about the riskiness/safety of John McCain and Barack Obama as president.

When asked who “would be the riskier choice for president – John McCain or Barack Obama,” the results were 35 percent for McCain and 55 percent for Obama. When asked who “would be the safer choice for president,” the results were 46 percent for McCain and 41 percent for Obama.

The numbers should be mirror opposites, but a clear framing effect skews them. The question never appeared before July, and was dropped in the August poll. To NBC and the Wall Street Journal: On behalf of behavioral economists, political psychologists, and generally curious American voters, throw us a bone and bring back the questions.

Addendum: @ Tristan. Check out this post if you haven’t already.

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From a speech last week by Congressional Budget Office Director Peter Orszag at the Retirement Research Consortium:

Distribution of the Age at Which Primary Beneficiaries Claim Social Security Benefits by Birth Year

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Curious about empirical findings that people showing symptoms of an illness avoid visits to a doctor, Ksenia Panidi constructs a formal model that draws heavily on the concept of loss aversion and reference points. The model shows why loss averse people have incentives to avoid visiting a doctor when threatened with a high risk of illness and when the benefits of getting treatment are low. The intuition is that any “gains” of good news about a treatment will be weighed against the reference point of seriousness of the illness. Given an aversion to losses, a person will avoid many potentially salutary treatments, since they tend to come with considerable risks. Panidi’s model is different because of its emphasis on the emotional costs and benefits of sickness and treatment rather than the financial ones.

A point of caution about Panidi’s predictions. As she notes, her model considers decision making in a single time period. Loss aversion is most pronounced at the initial reference point – the origin on a simple x,y graph. In the original prospect theory graph as one moves away from the origin in the loss direction, the strength of aversion weakens. What this means is that eventually, we should expect someone, even a very sick, very loss averse someone, to visit a doctor and accept treatment. Nevertheless, Panidi’s model suggests loss aversion may be a phenomenon worth paying more attention to as policymakers look for ways to expand preventative care.

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On Wednesday, the Nudge blog linked to David Leonhardt’s Wednesday column on people’s perceptions of inflation.

Price increases are simply more noticeable — more salient, as psychologists would say — than price decreases. Part of this comes from the notion of loss aversion: human beings dislike a loss more than they like a gain of equivalent size. If you have to sell your house for less than you bought it for, you’re really unhappy. You hate that ground chuck now costs $2.83 a pound, but you didn’t notice that oranges are 31 percent cheaper than they were a year ago.

For most people, the Consumer Price Index (or core inflation, if you prefer) is a relatively meaningless number – even if it provides a better picture of inflation than a gallon of gas. More meaningful is your personal inflation rate; the increase in prices of items in your household budget weighted by the amount of each item your buy.

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Michael Schrage of MIT wishes Amazon.com’s recommendation choice architecture could automatically distinguish between books he buys, books he browses, and books he buys as gifts for other people.

Lengthy interview with Richard Thaler in Fairfield Weekly by a former Ph.D. student of his, Phil Maymin. Thaler took the World’s Smallest Political Quiz and came up as a “libertarian.” But he corrected the record and called himself a “libertarian paternalist.” Thaler also explains the origins of the phrase libertarian paternalism.

The history of this phrase is that I was presenting a paper here at the University of Chicago on the “Save More Tomorrow” program, and a guy in the Economics Department was my discussant and he accused me of being a paternalist. Which as you know is the biggest insult that you can accuse anybody of being at the University of Chicago. And I said, “Well, I guess, but there’s no coercion here, so, maybe you should call me a libertarian paternalist.” That’s where it started.

David Leonhardt on how loss aversion affects our sense of inflation.

Dan Goldstein recalls a stickk.com-esque commitment strategy for finishing his dissertation. The ending is great.

I am reminded of the time I was a postdoc at Columbia University, on the job market, and deep in a publish-or-perish the phase of my career. I instituted a similar (though lower-tech) mechanism. My rule was that if I didn’t write a certain number of pages each day, I would lose five dollars. I think I lost about $60 on the scheme, though it did land me a job I love.

I remember being seriously conflicted about whom to give the money to if I procrastinated. I felt that if I gave it to a good cause, I would be continually justifying my procrastination as charitable. I felt that if I gave it to a bad cause, that would be evil. I also feared that I would start justifying my procrastination by telling myself the bad cause isn’t so bad. (Sound far-fetched? The idea that we might infer our preferences from our actions is a key, if not field-defining, idea from social psychology.)

In the end, I chose to leave the money on a seat on the New York subway. Maybe a good person would find it, maybe a bad person would find it, all I was certain of was regretting my procrastination. Given that you’re not evil, if you found $5 on the 1/9 train around 2005, I hope that it inched you closer to your goals.

Amol Agrawal thinks a restaurant in Powai is using behavioral economics to jack up his bill.

Paul Sweeney sends an email about an anti-nudge at his gym. What awaits members, courtesy of the gym’s owners, after they leave the dressing room following healthy workouts? Snickers bars on the counter.

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One of behavioral economics’ seminal insights is that people value gains differently than losses. Most of us are loss averse, which means we prefer to avoid a loss more than we enjoy the satisfaction of a seemingly equivalent gain (ie. losing $100 hurts more than winning $100 despite the identical value of the money involved). Economists who have tried to measure loss aversion have found that the odds of equivalent pain to pleasure are approximately 2:1. People will work to avoid losing $50 about as hard as they will to earn $100.

With that ratio in mind, a new survey from the Mineta Transportation Institute in San Jose, California, that asked California citizens about their preferences for “green” vehicle fees for different types of cars revealed the following finding:

Californians similarly supported another green transportation finance option – a new tax-and-rebate system on all new vehicles based on how much they pollute. People who buy a new vehicle that pollutes very little would receive a rebate of up to $1,000, and people who buy a vehicle that pollutes more would pay a tax up to $2,000. People who buy a vehicle that pollutes about the average amount would not pay a fee or receive a rebate. Sixty-five percent of respondents supported this proposal, and only 30 percent opposed it.

Continue reading the post here.

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