Income InSight. Social Security Timing. Tax Clarity. Is loss aversion the same as risk aversion? Mediation analysis indicated that outcome-induced loss aversion was responsible for effects of social distance on risk preferences. These findings demonstrate that social distance influences risk preferences via perceived loss aversion, which sheds new light on self-other differences in decision making.
Individual decisions are dramatically susceptible to the frame in which decision-making problems are described. The frame in terms of gains and losses has a remarkable influence on individual decision-making: When people make a choice between a risky and a sure option that have equal expected values, they tend to prefer the risky option in the loss frame, whereas they tend to be risk-averse in the gain frame Kahneman and Tversky, , ; Tversky and Kahneman, However, risk preference can change for both types of frame.
Does it also make a difference whether decisions are made for socially distant others, socially close others, or for oneself? Specifically, will people be less risk-averse in the gain frame and less risk-seeking in the loss frame when they make decisions for a stranger than for a close friend or for themselves? The effect of social distance on risk preference is not well understood for either frame type. Therefore, we investigated how decisions for oneself or another person i.
According to prospect theory, people are risk averse in the gain frame, preferring a sure gain to a speculative gamble, but are risk seeking in the loss frame, tending to choose a risky gamble rather than a sure loss Kahneman and Tversky, , ; Tversky and Kahneman, For example, using social, spatial, and temporal distance to represent psychological distance, Raue et al.
They found that participants were more risk averse in the gain frame when decisions were made in psychologically proximal than in more distal conditions; however, participants were equally risk seeking in the loss frame. Similarly, Sun et al. They showed that participants were more risk averse in the gain frame when decisions were made for themselves than for others, whereas no significant difference was observed between the two conditions in the loss frame.
Loss aversion reflects a prevalent avoidance behavior involving choices that could result in losses De Martino et al.
Loss aversion demonstrates the fact that people are more sensitive to losses than to gains of the same magnitude. Losses are weighted roughly twice as strongly as gains Tversky and Kahneman, Loss aversion has been used to account for framing effects on risk preference.
Specifically, people are more afraid of the potential losses derived from a risky prospect in the gain frame, which contributes to the prevalence of risk aversion in choices between probable and sure gains. On the other hand, people are also more aversive to certain losses derived from a sure riskless prospect in the loss frame, which contributes to the prevalence of risk seeking in choices between probable and sure losses Tversky and Kahneman, , Some research also provides evidence in favor of the notion that risk preferences in both frames may be driven by loss aversion Barkley-Levenson et al.
For example, Barkley-Levenson et al. Yechiam and Telpaz showed that participants tend to be more risk-seeking when the decision-making tasks involved potential losses, and they believed that this could be due to people paying more attention to losses. Therefore, a sure option is preferred to a risky option in a gain frame and a risky alternative is preferred in a loss frame if people feel a strong sense of loss aversion Ert and Erev, The stronger the level of loss aversion induced by a risky prospect in the gain frame and by a sure prospect in the loss frame, the more risk averse over gains and more risk seeking over losses people are.
In daily life, individuals make decisions not only for themselves but also for others Polman, , a ; Stone et al. Furthermore, decisions for others depend heavily on the social distance between ourselves and others Trope and Liberman, ; Sun et al. Social distance describes the affective closeness between others and ourselves, with a reference point of the self and a target being more psychologically removed from that point as social distance increases for a review, see Trope and Liberman, Previous studies have demonstrated that increased social distance works to reduce loss aversion.
For example, Polman b investigated the impact of making decisions for the self and others on loss aversion across a range of varied contexts, involving exchanging gift cards Study 1 , playing coin-toss gambles Study 2 , playing or rejecting some lotteries Study 3 , and paying to improve or worsen social aspects of life Studies 4a—e. They showed that loss aversion was markedly reduced when making decisions for others.
Similarly, Mengarelli et al. They found that loss aversion was remarkably mitigated when making decisions for others as compared with for the self. Additionally, using a virtual lab approach, Andersson et al. They also showed that decisions for others reduce loss aversion.
In sum, social distance between decision makers and targets influences loss aversion during the decision-making process Polman, b ; Andersson et al. Decision makers show less loss aversion as social distance increases i. Few studies have investigated the effect of social distance on risk preferences in both gain and loss situations.
Furthermore, the three existing studies Raue et al. For example, Sun et al. In addition, people often make decisions on behalf of concrete others rather than imaginary or abstract others in the real world. Therefore, using a concrete target to indicate others, the present research investigated the influence of social distance on risk preferences in both gain and loss situations.
Based on previous findings, we predicted that social distance will have an effect on risk preferences in both gain and loss situations via loss aversion. Specifically, we hypothesized that people may be more risk averse in the gain situation when making decisions for proximal targets than distal targets, but would be more risk seeking in the loss situation when making decisions for proximal targets compared to distal targets. We conducted two studies to test our hypothesis.
In Study 1, we manipulated social distance by asking the participants to make decisions for themselves and for a stranger. In Study 2, we manipulated social distance by asking the participants to make decisions for themselves, a close friend, and a stranger.
We also explored whether loss aversion might mediate the relationship between social distance and decisions made for the three types of target. Sixty-one undergraduate students participated in Study 1. Data from three participants were excluded from the analyses because they doubted that the decisions for the other person were real on the post-experiment self-report questionnaire.
In addition, data from one participant were also excluded from the analyses due to excessive risk seeking. This participant chose only risky options for all trials in two of the four conditions self-gain, self-loss, other-gain, and other-loss. This study was approved by the Research Ethics Committee of East China Normal University, and the written informed consent was obtained from all participants involved in the study.
We adopted a modified version of the cups task Weller et al. These are the following combinations: 0. In each trial, a cup was presented on one side of a screen. The other side of the screen was identified as the risky side where an array of two, three, four, or five cups was presented, and the choice of one cup leads to a specified amount of money being gained or lost, whereas selection of the other cups leads to no gain or no loss.
As in the previous study Xue et al. Illustration of the cups task and experimental procedure. A A gain situation. The risky option was presented on the left side of the screen, with a 0. B A loss situation. The risky option was presented on the right side of the screen, with a 0.
C Experimental procedure. In each block, an instruction was presented only at the first trial indicating whether the subsequent series of decisions were made for oneself or for another person i. During the decision phase, the gain and loss domain trials were presented in a pseudo-random order within each block.
Participants were informed that the same-sex stranger had been randomly selected from among the participants of another experiment, and that they would never meet. The formal experiment consisted of four blocks two blocks for each decision target. Presentation order of these blocks was counterbalanced across participants. At the beginning of each block, an instruction indicating whether it was a self decision-for-self or stranger decision-for-stranger block was shown to the participants for ms Figure 1C.
Each trial started with the presentation of a central fixation point with a duration that varied randomly from to ms. Two risky and sure options were randomly positioned to the left or right of the screen in every trial. The alternatives remained on the screen until the participants made a choice. Notably, the outcome of the choice was not revealed to the participants in each trial, to exclude potential effects of learning from reward feedback Suzuki et al.
Within each block, 40 trials were presented in a pseudo-random order in which no more than three successive trials were from the same decision situation, consisting of five repetitions for each of the eight combinations four combinations for each of gain and loss.
In total, each participant performed trials. They were informed that the computer would randomly select one trial from the self trials at the end of the experiment, and the outcome of the selected trial would be added to or subtracted from the initial endowment, and a payment would be implemented depending on their actual choice.
Because participants did not know which trial would be selected, they should have treated every trial independently De Martino et al. Before the formal experiment, each participant performed eight practice trials to familiarize themselves with the experimental task.
Follow-up simple effects analyses revealed the following. Error bars indicate standard error. By manipulating social distance, we aimed to investigate the effect of social distance on risk preferences in both gain and loss situations. In line with our hypothesis, people were more risk averse in gain situations when making decisions for themselves than for a stranger, and were more risk seeking in loss situations.
Our findings indicated that social distance between decision makers and targets has a significant effect on risk preferences in both gain and loss frames, and moreover, this effect is stronger in loss frames than in gain frames.
Yet, in real-world scenarios it is more typical that people make decisions for a close friend as opposed to a complete stranger Braams et al. Furthermore, important decisions are often made for a close friend Wu et al. Utilizing a behavioral economics nudge may be effective in this type of situation.
Reframing the decision as one that could lessen a loss, or has the opportunity to generate a gain, may help ameliorate the client's loss aversion. Explaining that it is best to sell because the stock may continue to fall in value or that selling the stock will free up some cash that could be used for a better investment may be helpful. Additionally, pointing out the potential tax benefits of realizing the investment loss may be useful in reframing the decision as one that could generate a potential gain.
Genesove, D. Haigh, Michael S. Kahneman, Daniel, and Amos Tversky. The views and opinions expressed herein are those of the author, who is not affiliated with Hartford Funds. The information contained herein should not be construed as investment advice or a recommendation of any product or service nor should it be relied upon to, replace the advice of an investor's own professional legal, tax and financial advisors.
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This material is intended for use by financial professionals or in conjunction with the advice of a financial professional. Risk Aversion vs. Loss Aversion: What is the Big Difference? As an advisor, it is important to recognize that loss aversion can influence your clients to manage the investments in their portfolios in a suboptimal way.
MIT AgeLab. Key Takeaways Risk aversion and loss aversion are different and have different influences on client financial decisions.
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