The strange claim that loss aversion is irrational
The claim is common; it appears, for instance, here.
I contend that this claim is itself irrational, and loss aversion makes perfect sense. Whatever I have now, I am getting by with it, and a loss of some of it might endanger my lifestyle, my family, or even my life.
Whatever I don't have now, I am getting by without it. And while getting it might seem attractive, I really don't know: perhaps it would ruin me! (Think of the curse of the lottery winner.)
I contend that this claim is itself irrational, and loss aversion makes perfect sense. Whatever I have now, I am getting by with it, and a loss of some of it might endanger my lifestyle, my family, or even my life.
Whatever I don't have now, I am getting by without it. And while getting it might seem attractive, I really don't know: perhaps it would ruin me! (Think of the curse of the lottery winner.)
I don't think loss aversion is irrational but framing bias often is. Even that is not always, sometimes the path matters as much as end, but loss aversion is often exploited by framing bias, the cure being to reframe without loss aversion.
ReplyDelete*Most* such fallacies or biases do in fact have such heuristic value -- you can make the same point about e.g. "status quo bias" or "appeal to authority/expert".
ReplyDeleteI hope you realize that an appeal to authority is only a fallacy when the person is not an authority in the field in question?
DeleteIn any case, if loss aversion has heuristic value, why call it irrational?!
Like with fallacies, applying the heuristic *incorrectly* or "too broadly" or "in ways that ignore what information you have" *is* irrational. But at that point, it's a circular argument. "Don't do X, when X would be something you shouldn't do." Uh, thanks.
DeleteGene, his point is correct, BUT FRAMED POORLY.
ReplyDeleteWhen we have an asset whose price is rising, we get greedy, and instead of saying, "Hey, this is overvalued, I should sell", we just wait for it to get higher until the bubble explodes.
When we have an asset whose price is falling, we sell it immediately before it causes a deeper loss. We don't wait for it to rise.
If we applied the same logic to losses as to gains, we would accept a small profit rather than wait for the bubble to burst.
Or conversely, sit out on the asset whose price is falling, confident that its price will rise again.
Human beings unfortunately do not do either of the above most of the time.
That is the not very logical part of "loss aversion".
No, Prateek, that is not what loss aversion means.
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